ECB keeps rates on hold as recession fears mount

The European Central Bank held its key interest rates steady, as expected yesterday, leaving borrowing costs at historic lows amid new signs the eurozone is in recession.

The ECB’s policy-setting governing council voted to leave the rate for its main refinancing operations unchanged at one per cent at its regular monthly meeting , brought forward by one day owing to the Easter holidays.

No rate changes had been expected this week after two recent rate cuts and unprecedented amounts of liquidity pumped into the banking system to avert a possible credit crunch in the eurozone economy.

Analysts and central bank watchers said that the bank, the guardian of the euro, would want to see how those measures have played out before taking further action.

But new evidence that the eurozone is in recession came yesterday with the release of the composite Purchasing Managers Index (PMI) which hit a three-month low in March.

Battling the relentless debt crisis, the eurozone took a first step towards recession when its economy shrank by 0.3 per cent in the fourth quarter of 2011. A recession is defined as two consecutive months of economic contraction.

The PMI, a survey of 4,500 manufacturing and services firms, showed that activity in the services sector dropped for the second month running in March, while manufacturing output shrank for the first time in three months.

The ECB has, since December, thrown open its liquidity floodgates twice, flooding the banking system with cheap funds in order to avert a dangerous credit squeeze.

Banks have borrowed more than €1trillion from the ECB at exceptionally low interest rates.

The ECB hopes the banks will lend the money to households and businesses and also use it to bring down government borrowing costs.

The measure does indeed seem to have succeeded in calming the markets, at least for now, even if analysts agree it will not be enough on its own to solve the eurozone’s crippling debt crisis and will merely buy time.

ECB watchers are therefore keen to hear whether president Mario Draghi has any further cards up his sleeve to bring the long-running sovereign debt crisis to an end, or whether the bank is now drawing up a so-called “exit strategy” to wind down the raft of recent exceptional policy measures.

“The key question is what signals president Mario Draghi will give at the press conference on the bank’s willingness to offer further unconventional support,” said Capital Economics chief European economist Jonathan Loynes.

“He will presumably have to acknowledge that some of the market optimism which followed the long-term refinancing operations in December and February appears to be wearing off, with Spanish 10-year bond yields moving decisively back above 5.5 per cent today and the euro dropping,” Loynes said. However, he added, Draghi would likely stress that the liquidity was designed to prevent a credit crunch, not to support sovereign debt markets.