UPDATE 3-ECB holds rates, liquidity decisinon next month

Published: 05 Nov 2009 17:16:59 PST

* Keeps rates at 1.0 pct for sixth month

* ECB President Trichet sees gradual recovery in 2010

* Trichet: decision on 12-month money to come next month (Adds Trichet quotes)

FRANKFURT, Nov 5 - The European Central Bank kept interest rates on hold at a record low 1.0 percent on Thursday and President Jean-Claude Trichet said it saw signs of an economic pick-up which would lead to a gradual recovery in 2010.

"The latest information continues to signal an improvement in economic activity in the second half of this year," Trichet told a news conference.

"The Governing Council expects the euro economy in 2010 to recover at a gradual pace, recognising that the outlook remains subject to high uncertainty," he said.

Investors were braced for signs that the ECB will soon start weaning banks off cheap and abundant liquidity but Trichet said a decision on the ECB's programme of offering 12-month money to banks at just one percent would be taken next month.

He added, however, that he would not "dispel" a market view that the scheme would not be extended beyond December.

"I will not comment on the spread or indexed rates. We will examine the situation and take our decision next time," Trichet said.

All 78 economists polled by Reuters last week had expected the ECB to leave interest rates at a record low this month, with no change expected until late 2010. [ECB/INT]

The euro <EUR=> was little changed after the decision at around $1.4877.

(For graphic of global interest rates see http://graphics.thomsonreuters.com/RNGS/ECO/RATES.jpg )

The U.S. Federal Reserve made no change to policy settings on Wednesday despite growing confidence of a recovery. The Bank of England also left its rates untouched, but said it would expand its quantitative easing programme by 25 billion pounds. [ID:nnL5152809]

The vast majority of analysts expect the ECB to start withdrawing generous liquidity supplies before it raises rates, and futures pricing suggests market rates rising in early 2010.

(For graphic of ECB rate forecasts against market rate expectations see http://graphics.thomsonreuters.com/109/EZ_ECBPOL1009.gif )

Many of the emergency measures brought in to counter the financial crisis run only "beyond the end of 2009", meaning the ECB will have to decide soon whether to extend them or not. [ID:nLR138405])

"The Governing Council will make sure that the extraordinary liquidity measures taken are phased out in a timely and gradual fashion and that the liquidity provided is absorbed in order to counter effectively any threat to price stability over the medium to longer-term," Trichet said.

Germany's Axel Weber said last week that the policy of unlimited funds at main liquidity operations should be kept on, while very long-term liquidity operations could go sooner. [ID:nLT301586]

MAY HOLD OFF

By next month's meeting, the ECB will have updated staff economic projections and the first forecasts for 2011, the crucial period for today's monetary policy decisions given the long lead time.

Inflation remained negative in October, at -0.1 percent, but is expected to turn positive again in November given a 15 percent rise in oil prices in the last month <LCOc1>. "(Inflation) is expected to turn positive again in the coming months and to remain at moderately positive rates over the policy-relevant horizon," Trichet said.

Growth data over the last month have been encouraging, with euro-zone manufacturing activity growing in October for the first time in 17 months and its service sector expanding at its fastest in nearly two years. All this has boosted expectations that the 16-nation bloc returned to growth in the third quarter.

The European Commission on Tuesday revised up its growth forecast for next year to 0.7 percent and sees an acceleration to 1.5 percent in 2011, after a 4.0 percent fall this year. [ID:nL3159517]

The IMF sees 0.3 percent growth in 2010. [ID:nN30210462]

One threat to that is the strength of the euro, which has risen 16 percent against the dollar <EUR=> in the last eight months and about 3.5 percent using the ECB's preferred trade-weighted measure <EUREER=ECBF>.

Economists are also keen to gauge the ECB's assessment of credit conditions, after a pick-up in new lending on a monthly basis and an easing in tightening their credit standards in Q3. [ID:nLS670187]

"It looks like we are approaching a turnaround in the credit cycle," Unicredit's Valli said. "However, the ECB is likely to remain very cautious until business lending picks up."