Frankfurt - The European Central Bank (ECB) is expected to leave interest rates on hold at an historic low Thursday as it tries to balance out concerns of deflation and tighter credit against signs that the 16-member eurozone has started to shake off its steepest economic slump in more than 60 years. Indeed, the economic uncertainty unleashed by the downturn along with evidence that consumer prices have tumbled deeper into negative territory has lead analysts to believe that the ECB will keep its benchmark refinancing rate on hold at 1 per cent well into the new year.
"The bank is biding its time for now, hoping that its generous liquidity provision will achieve the desired boost to commercial bank lending," said Jennifer McKeown, European economist with the research group Capital Economics.
Moreover, this means that with ECB having pumped a massive injection of funds into the eurozone's economy, the bank's 22-head rate-setting council is unlikely to announce this week any new measures to help spur economic growth.
Eurozone rates have been on hold since May with the ECB having delivered up until then a series of rapid-fire cuts aimed at shoring up eurozone economic confidence in the face of the growing global financial crisis. The bank's refinancing rate stood at 4.25 per cent in October last year.
To be sure, it is a sign of the scale of the downturn that has ravaged the eurozone over the last 12 months that the ECB is meeting at all this month.
Like the financial markets across Europe, the ECB normally winds down this time of year for the European summer.
As a reminder of the fragile state of the global economy, this week's ECB meeting is also been held against the backdrop of rising unemployment as the fallout from the recession catches up with labour markets around the world.
Eurozone unemployment jumped to 9.4 per cent in June to reach its highest level in a decade, amid concerns that the layoffs will in the currency bloc will surge by the end of the year.
Meanwhile, June unemployment in Japan hit a six-year high of 5.4 per cent with unemployment in the United States rising to 9.5 per cent in June, its highest level in more than a quarter century.
But despite the ECB's massive injections of money into credit markets, data released last week showed eurozone banks still reluctant to lend with surveys from leading European business groups underscoring industry's current concerns about access to financing.
Nevertheless, since the bank met at the beginning of last month a steady stream of forward-looking indicators have pointed to the eurozone starting to climb out of recession.
The European Commission said its closely watched economic sentiment survey hit its highest level in eights months in July.
"July's sharper-than-expected increase in economic sentiment adds to evidence that the eurozone recession is losing steam, and will fuel hopes that that the economy may reach a floor later this year," said ING Bank economist Martin van Vliet.
However, figures released last week showed consumer prices in the eurozone falling more than forecast from minus 0.1 per cent in June to minus 0.6 per cent last month. This left consumer prices well below the ECB's annual target of close to but below two per cent.
ECB chief Jean-Claude Trichet has insisted that negative inflation in the eurozone was likely to be short-lived, telling an ECB press conference last month that the latest consumer price data reflected only temporary effects.
But dwindling consumer prices have also helped to stoke fears about the threat of falling prices becoming prolonged, which in turn could undercut hopes of an early rebound in the eurozone economy from recession.
This, according to McKeown, could force the ECB to take additional action to help drive economic growth.
"With the economy still contracting and deflationary pressures building, there remains a chance that outright quantitative easing will eventually be required," she said.
