Rate hikes shelved as ECB battles debt crisis

The European Central Bank is likely to signal a halt to its rate hike cycle at its meeting on Thursday, economists said, as the debt crisis undercuts growth in the 17-country eurozone. Following two controversial rate increases in April and July, some even expect a reversal in policy with interest rate cuts in the coming months, after core economies France and Germany reported a sharp slowdown in growth. "With inflation risks probably no longer deemed on the upside, the chances of further interest rate hikes have evaporated and a reversal of earlier increases now seems likely," said Jennifer McKeown at Capital Economics. Markets will be looking closely at revised inflation and growth forecasts published on Thursday, with both indicators expected to be pushed lower as the debt crisis rages, opening the door to potential rate cuts. "We expect the ECB to shave its growth forecasts modestly and to make a more meaningful revision to its inflation forecast when the bank presents new staff projections," said Berenberg Bank chief economist Holger Schmieding. Other analysts believe however that the ECB will keep rates on hold for the foreseeable future, if only for consistency's sake. "Unless the growth and inflation outlook deteriorates markedly, there is no reason to expect that the ECB might reverse its hikes and send the key rate back to its historical low of one percent," said Michael Schubert from Commerzbank. In London, the Bank of England also meets Thursday but economists expect no no change there from its record low lending rate of 0.50 percent as the country grapples with the effects of a global slowdown. In Frankfurt, governors meeting at the ECB's Eurotower will have a raft of disappointing economic data to digest, including a measly 0.1-percent gain in German GDP while neighbouring France failed to grow at all. Forward-looking indicators offer little comfort, with the EU's consumer and business confidence indicator falling for a sixth consecutive month in August and Germany's key Ifo business confidence index hitting a 14-month low. ECB President Jean-Claude Trichet will also be bracing for tough questions about the bank's unconventional and controversial policy of buying the bonds of distressed eurozone countries such as Spain and Italy. The decision, made as investors were driving up Italian and Spanish borrowing costs to unsustainable levels, has touched off a raft of criticism from inside and outside the ECB. In a highly unusual outburst, Germany's president Christian Wulff said the purchasing of eurozone sovereign bonds set a risky precedent, allowing countries to avoid taking steps to balance their strained public finances. "That is asking for trouble in the long run and can only be tolerated in the interim," he said. Meanwhile, Jens Weidmann, the head of Germany's powerful central bank, who sits on the ECB's Governing Council, argued that buying eurozone debt would reduce the credibility of the bank in the longer term. Conscious of the criticism, Trichet has called for a swift implementation of decisions made at a recent crisis EU summit that mandates the eurozone's rescue fund to take over this bond-buying function. McKeown from Capital Economics suggested that "Trichet might well hint that the ECB is unwilling to continue buying Italian and Spanish government bonds indefinitely." This would pile the pressure back on to Madrid and Rome to get their fiscal houses in order, after Italy appeared to be rowing back on unpopular austerity measures. Another key issue facing ECB policymakers is the state of eurozone banks, after the managing director of the International Monetary Fund, Christine Lagarde, called for them to be recapitalised, with public money if needed.