ECB maintains rate freeze and shrugs off inflation fears

The European Central Bank yesterday kept interest rates on hold as it sought to strike a balance between improving growth prospects and the impact of higher oil prices.

The decision means that interest rates in the 12-nation eurozone remain at an historic low of 2% for the 15th month in succession.

The ECB's cautious stance is in contrast to the US Federal Reserve and the Bank of England's monetary policy committee, both of which have raised rates this summer.

"Economic recovery in the euro area has maintained its momentum and should remain firm in coming quarters," according to ECB president Jean-Claude Trichet. The ECB expects growth of between 1.6% and 2.2% this year and 1.8-2.8% in 2005.

Mr Trichet warned that, though wage inflation remained subdued because of high unemployment, the rise in the oil price meant that eurozone inflation was likely remain above the ECB's 2% ceiling. The bank said it expected inflation to fall back below 2% next year.

Mr Trichet said the ECB's governing council had not discussed cutting borrowing costs yesterday, but he was more oblique in his response to questions about a rate rise.

"We maintain our rates as they are and we are pretty vigilant because there are upside risks to price stability."

Analysts said the comments suggested the ECB was not about to change rates in the near term, but they were divided about whether the next move would be up or down.

"All we can say is that any hope for a rate cut any time soon is not there," said economist Michael Rottman at Hypovereinsbank in Munich.

Elwin de Groot at Fortis Bank in Amsterdam said: "Overall I think he painted a rather optimistic picture going forward, both this year and next. If the scenario of the ECB comes out then at some point further down the road we might see the first rate hike."

Mr Trichet took a robust approach to a European commission discussion of possible changes to the stability and growth pact, due today.

France and Germany are among the member states that have breached the pact's rules on government deficits, leading to calls for changes to a structure which is widely seen to have lost credibility.

But Mr Trichet said the ECB would have no truck with radical change, arguing that there was little need to alter the wording that threatens governments with financial penalties if deficits exceed 3% of gross domestic product.

The bank is concerned that allowing governments more leeway on deficits would take the pressure off them to pursue the market reforms which the ECB regards as crucial to increasing competitiveness.

But Mr Trichet said the pact could be made more efficient by improving incentives for governments to run surpluses during periods of strong economic performance in order to counter the effects of sluggish growth or recession.