The European Central Bank signalled on Thursday that it had halted a cycle of interest rate rises begun just five months ago, saying eurozone inflation risks were no longer skewed to the upside and economic growth would be slow at best. The European Central Bank (ECB) left rates at 1.5 percent, following hikes in April and June.
ECB President Jean-Claude Trichet said there were "intensified downside risks" to the economic outlook for the 17-country eurozone, marking a significant change in stance from last month when the bank was focused on inflation risks. "The change in tone firmly shelves rate hikes and even opens the door to rate cuts if the economic outlook deteriorates further," said ABN Amro economist Nick Kounis.
Trichet said inflation should fall below 2 percent in 2012 from 2.5 percent last month, and that price risks were "broadly balanced". That assessment marked a change from last month, when he said there were "upside risks to price stability". "We expect the euro area economy to grow moderately, subject to particularly high uncertainty and intensified downside risks," Trichet told a news conference after the ECB left rates at 1.5 percent, following hikes in April and July.
"We are in a situation which is exceptionally demanding," Trichet said, making an impassioned defence of the ECB's record and its handling of the euro zone debt crisis when asked about calls from some in Germany for a return to the Deutschmark. The ECB had delivered price stability "impeccably", he said, holding his last monthly news conference at the ECB's Frankfurt news conference before his term expires at the end of October. Next month, the ECB Governing Council meets in Berlin.
"I would like very much to hear the congratulations for an institution which has delivered price stability in Germany over almost 13 years at 1.55 percent approximately ... which is better than what has ever been obtained in this country over the last 50 years," he said, raising his voice and visibly moved.
He also took aim at Germany, France and Italy for watering down the budget rules in Europe's Stability and Growth Pact, saying this contributed to the fiscal mess that ultimately pushed the ECB into buying up the debt of troubled economies on bond markets. "If we have embarked into the SMP (bond) programme...it was because the governments in question had not behaved properly."
ECB staff cut their growth forecasts to a range of 1.4-1.8 percent this year from the 1.5-2.3 percent seen in June. Next year, growth is expected to be between 0.4 and 2.2 percent, down from 0.6 to 2.8 percent previously. Inflation is now predicted to fall back to between 1.2 and 2.2 percent next year, for a midpoint of 1.7 percent, which would be below the central bank's target of close to but below two percent.
"A very thorough analysis of all incoming data and developments over the period ahead is warranted," Trichet said. "We will continue to monitor very closely all developments." All 75 of the economists polled by Reuters ahead of the ECB's decision correctly forecast rates would stay on hold at this meeting.
Following the two rate rises earlier this year, all the signs from policymakers were that further rises had also been pencilled in but a deterioration in the economy and debt crisis since then has altered the outlook dramatically. Policymakers' failure to resolve the debt crisis has eroded confidence in the eurozone, and some private sector economists put the chance of a return to recession at least 50 percent. While inflation remained at 2.5 percent last month, well above the ECB target, such is the concern about faltering growth that financial markets are pricing in a cut to rates as early as December.