ECB expected to hold interest rates at historic low today

The eurozone's benchmark interest rate will stay at its historic low of one per cent today as deflation fears subside and the 16-nation economy shows signs of a rebound, analysts said yesterday.

"While keeping rates on hold this week, the European Central Bank can shift gears from crisis management to safeguarding the momentum" seen in France and Germany, ING senior economist Carsten Brzeski said.

Observers will focus on the latest forecasts for eurozone inflation and growth by bank staff that ECB president Jean-Claude Trichet is to present at a press conference following the rate decision in Frankfurt.

Analysts expect a bleak picture presented in June to be brighter even though rising unemployment and a potential credit squeeze could still choke off sustained economic growth.

Fears that deflation could grip the eurozone have begun to subside however, since the European Union said consumer prices slipped by just 0.2 per cent in August, far less than the 0.7 per cent level in July.

ECB policymakers maintain that an appropriate level of inflation will return once comparisons with a mid-2008 spike in oil prices have passed.

Economic activity is also showing signs of life, and even though the eurozone recorded a second-quarter contraction of 0.1 per cent, it was a big improvement from a 2.5 per cent drop in the first three months of the year.

France and Germany, the two biggest eurozone economies, both posted growth in the second quarter, and ECB staff forecasts will probably be revised higher as a result.

In June they expected activity to contract by 4.6 per cent this year and to shrink by a further 0.3 per cent in 2010.

Sustained growth faces two major hurdles however, rising unemployment and tighter lending conditions that could curb consumption and business investment.

Banks remain reluctant to open their credit taps because they fear a wave of recession-related loan defaults and because they want to bolster their own weakened balance sheets.

In Germany, Economy Minister Karl-Theodor zu Guttenberg on Tuesday unveiled a multi-billion euro proposal to fight credit problems by lending directly to banks and bolstering insurers.

Mr Guttenberg said the plan was aimed at Germany's "Mittelstand" - the small and medium-sized firms that form the backbone of the economy.

"We want to ensure that small and medium-sized companies in particular can gain access to enough credit, even in economically difficult times, to carry out important projects," he said in a statement.

Eurozone unemployment meanwhile has reached 9.5 per cent, its highest level in more than 10 years, with more than 15 million people out of work according to figures published by the EU's statistics service Eurostat.

Despite the credit and jobs issues, the ECB will probably say current interest rate levels are "appropriate," a term which tells markets not to expect a change in the near future.

Economists believe the key rate will remain at one per cent until well into next year.

Citigroup analysts said: "In our view, the ECB will leave rates unchanged until the fourth quarter of 2010."