ECB to hold rates, may shake up collateral rules

By Marc Jones

FRANKFURT (Reuters) - The European Central Bank is widely expected to leave interest rates at 4.25 percent later on Thursday, with a new set of staff economic projections and a likely rejig of collateral rules set to provide this month's fireworks.

The monthly meeting of the ECB's 21 policymakers kicked off at 3 a.m. EDT with more than usual on the agenda. Updated staff projections will arm them with an up-to-date prognosis of the economic outlook while the delicate issue of collateral rule changes could raise the temperature of the meeting.

The projections are not expected to make happy reading. Analysts expect 2008 and 2009 growth forecasts be revised down and inflation forecasts to be pushed up for 2008 at least

The last set in June put growth at 1.5-2.1 percent this year and 1.0-2.0 percent in 2009. Inflation was seen between 3.2-3.6 percent this year and 1.8-3.0 percent next year.

"The ECB will have to acknowledge that the growth outlook has weakened and we expect the staff forecast to be revised down for 2009 probably to a mid point of 1.2 percent," said Deutsche Bank economist Thomas Mayer.

The Organisation for Economic Cooperation and Development (OECD) chopped its 2008 growth forecast for the 15 nation euro zone earlier this week to 1.3 percent from 1.7 percent and it was confirmed the region suffered its first ever quarterly contraction in April, May and June.

The euro sank to a new eight-month low against the dollar on Wednesday after July retail sales and August services sentiment signaled more weakness ahead.

In an newspaper interview published on Thursday, Dutch governing council member Nout Wellink warned the current credit market turmoil could last for years.

COLLATERAL THINKING

Changes to collateral rules are likely to be the other key news of the day as the ECB looks to put a stop to banks exploiting current rules and swapping complex, untraded and near impossible-to-value assets for ECB funds.

"With the interest rate decision well anticipated the key focus will probably be the collateral issue," said Mayer.

"There has been speculation they will announce larger haircuts and may require that securities have been traded at least once."

The ECB announces the interest rates decision at 1145 GMT and President Jean-Claude Trichet and Vice-President Lucas Papademos explain it at a 1230 GMT news conference.

Analysts see it as a virtual certainty that rates will be kept on hold this month as the ECB's inflation worries trump any concerns about the region's wilting economic growth. All 83 analysts polled by Reuters expect no change.

"It's clear that rates will stay where they are." said ABN Amro economist Dario Perkins.

"The last month has seen a pretty dreadful run of economic data. All the major indictors have declined and GDP has contracted, but ECB officials have made it clear with their recent comments that they are only concerned about inflation."

Euro zone inflation eased only slightly to 3.8 percent in August, roughly double the ECB's target.

Executive Board Member Juergen Stark last week became the first policymaker to admit broad-based second-round inflation effects were surfacing, while Papademos said any wage-price spiral would trigger higher rates

Up until that point financial markets were increasingly talking up the likelihood of rate cuts this year as gloomy data stacked up but Eonia rate futures have turned since the renewed offensive.

The ECB is particularly nervous about over-generous wage deals as European unions such as Germany's IG Metall ask for well-above inflation pay increases for workers to balance out the recent oil and food price-driven jumps in living costs.

Analysts therefore expect Trichet to balance his acknowledgment of lower growth by maintaining a tough tone on knock-on inflation effects.

"The central bank head should make it clear that worries about second round effects remain and that the risks to price stability are still to the upside despite the fall in oil prices and the slowdown in economic growth," said Fortis Chief European Economist, Nick Kounis.

(Reporting by Marc Jones; Editing by Ruth Pitchford)

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