Two-speed eurozone a new test for the ECB

The European Central Bank, which has become used to handling crises, must now draft a monetary policy for what is becoming a two-speed economic zone, economists say.

“The good news is - the eurozone economy is still on a growth path. The bad news is - there is still a deep division between eurozone countries,” Commerzbank analyst Christoph Weil said.

After ECB governors make their decision on interest rates today, president Jean-Claude Trichet is to unveil the latest forecasts by bank staff for eurozone growth and inflation.

“The ECB is universally expected to leave rates on hold,” Bank of America Merill Lynch analyst Silvia Ardagna noted.

The 2010 growth rate will surely be raised from an estimate in June of 1.0 per cent, however, while the outlook for 2011 is more uncertain.

Countries like Germany have rebounded from a deep recession last year but others on the 16-nation eurozone’s periphery will struggle for months and possibly much longer to get growth back on track.

Commercial bank reliance on central bank funds meanwhile means the ECB’s interest rate of one per cent will remain at its record low and that Trichet could announce an extension of offering unlimited loans for up to three-months.

The ECB’s headline rate compares with just 0.1 per cent at the Bank of Japan, while the Bank of England’s benchmark rate is 0.50 per cent and the US Federal Reserve has kept its Fed funds rate at virtually zero.

Fed chief Ben Bernanke said Friday it will take even more aggressive steps to boost growth if the economic outlook “deteriorated significantly,” but added that prospects for a US growth pick up in 2011 appeared to “remain in place.” The eurozone economic backdrop is pretty good in contrast, with overall growth of one per cent in the second quarter and inflation at a tame 1.7 per cent in July, although unemployment remains stuck at 10 per cent.

Business activity varies widely across the zone however, expanding by a quarterly record of 2.2 per cent in Germany but contracting by 1.5 per cent in Greece, according to the EU statistics office Eurostat.

Major economies like France, Italy and Spain posted modest growth rates that ranged from 0.6 to 0.2 per cent, and the region could face stronger headwinds later this year.

“Calibrating the common monetary policy won’t be easy if core eurozone enjoys robust growth while the periphery suffers from continued economic weakness and from periodic bouts of tensions in the financial sector and sovereign bond markets,” UniCredit chief economist Marco Annunziata said.