By Johanna Treeck

FRANKFURT (MNI)- The European Central Bank Thursday signaled an end
to its tightening bias, noting that inflation risks were no longer
tilted to the upside and that economic prospects had weakened
significantly.

President Jean-Claude Trichet’s introductory statement and later
comments, however, offered no indication that the central bank is
mulling an outright reversal of its April and July interest rate hikes
at the current juncture.

Much as expected, the ECB changed its assessment of inflation risks
to “broadly balanced” from the previous view that they were “on the
upside.” Coupled with the new 2012 ECB staff forecast putting HICP at a
midpoint of 1.7% — well below the bank’s inflation threshold, though
essentially unchanged from the June forecast — the clear implication is
that any more tightening in the near-term is off the agenda.

This is especially true in light of the notable downward revision
to the ECB staff forecasts for growth, to a midpoint of 1.3% in 2012
from the previous projection of 1.7%. The Governing Council now sees
risks to the growth outlook on the downside, a change Trichet described
as “significant.”

However, Trichet also indicated that the recent growth slump may in
part be due to one-off factors, including a hard-to-match spurt in the
first quarter, adverse effects resulting from the Japanese earthquake,
and the lagged impact of past oil price increases.

The decision to keep interest rates on hold this month was taken
“unanimously,” Trichet said. He would not offer any insight into the
contents of the debate or the possible course going forward, other than
to say that the central bank stands ready to do “all that is needed.”

The ECB is clearly keeping its options open should things
deteriorate further. But there were no sings of any rate cut
considerations at present. Trichet defended the ECB’s previous rate
hikes and observed that “short-term interest rates are low” and that the
“monetary policy stance remains accommodative.”

While he did concede that “some financing conditions have
tightened”, he said that this was only the case in “parts of the euro
area.” Importantly, Trichet stressed that the central bank is relying
mainly on non-standard measures to address this failure of the
transmission mechanism.

As long as inflation runs above target this year, and interest
rates are still seen as low and accommodative, there would appear to be
little reason for the ECB to undo its April and July rate increases.
Especially in the face of tough credibility problems the ECB is facing
in Germany and other like-minded Eurozone countries over its
non-standard measures, the ECB will want to avoid any appearance of
going soft on inflation.

Trichet’s impassioned assertion that the ECB has ensured price
stability better than the Bundesbank ever had and should be
congratulated for it suggests he is not prepared to let the bank’s
reputation for a strict inflation focus be questioned during what
remains of his tenure.

There is little indication that the ECB will be able to become more
orthodox in terms of its non-standard measures any time soon,
particularly if it wants to avoid having to address the pockets of
tighter financing conditions with monetary policy.

In the wake of recent interbank lending tensions, Trichet assured
that the ECB stands ready to continue its generous liquidity provisions
for as long as necessary. “Liquidity in Europe is a false problem,” said
Trichet. “We stand ready to provide liquidity as we have done in the
past, taking into account the needs of the banking sector.”

While he was less committal about ongoing ECB intervention in the
secondary sovereign debt market, Trichet stopped short of confirming his
previously stated intention of ending the controversial bond buying
program once the European bailout fund, the EFSF, has the authority to
take over that task.

Rather, he suggested that the ECB could stop buying bonds only if
market conditions allowed — once the EFSF was vested with its new
powers and national governments honored their promises to reform public
finances under the surveillance of their European peers.

These are of course big “ifs”, and governments may well not be able
to overhaul their fiscal policies substantially and quickly enough to
allow a permanent ECB-exit from the secondary market.

Should the sovereign debt crisis and global economic slowdown feed
a “dangerous spiral,” as President-designate Mario Draghi warned Monday,
the ECB may yet be forced to cut rates — more likely than not on
Draghi’s watch, which starts November 1. For now, however, there
probably will be no action on the interest rate front, though active use
of non-standard measures will continue.

–Frankfurt newsroom +49 69 72 01 42; e-mail: jtreeck@marketnews.com

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