ECB leaves rates unchanged as economy slows

[May 03, 2012]  FRANKFURT, Germany (AP) -- The European Central Bank has left its benchmark interest rate unchanged despite worsening growth forecasts for the 17 countries that use the euro.

The bank's governing council kept the key refinancing rate at a record low of 1 percent.

Market attention will focus on bank President Mario Draghi's growth outlook at a news conference, and whether he will signal the bank could be more open to a possible rate cut down the road.

Draghi has called for a "growth compact" among governments but has not given a detailed idea of what he meant. He and other ECB officials have pressed governments to make their countries more business-friendly by cutting regulation and restrictions on hiring and firing, not to add stimulus spending.

Austerity and a focus on fiscal discipline has been the main prescription across Europe for dealing with a debt crisis that's afflicted the continent for nearly three years and has raised the specter of the breakup of the single currency. Three countries -- Greece, Ireland and Portugal -- have already required bailouts because of unsustainable levels of debt.

The meeting Thursday in Barcelona took place with an additional 2,000 police on the streets because of fears that protests aimed at Spanish government cutbacks would turn violent. Spanish authorities imposed airport and border passport checks, suspending provisions of the Schengen treaty that permit people to cross borders without showing documents.

Several hundred students protesting increases in college costs gathered near the University of Barcelona as the ECB meeting began in a heavily guarded hotel, but there were no initial reports of unrest.

Spain has been the recent focus of the eurozone debt crisis, as its borrowing costs have risen on bond markets. The government has slashed spending to reduce the deficit, but that has weighed on growth and the country is in a recession after six months of falling output. Unemployment is at 24.1 percent, and it's 51.1 percent for people under 25.

Yet the bank is unlikely to offer much help unless things get significantly worse. It is hindered from raising interest rates by an inflation rate that stubbornly remains above the ECB's goal of just under 2 percent. A rate cut might help spur growth but could worsen inflation.

The refinancing rate sets the cost of central bank credit to private-sector banks and influences a host of other short-term interest rates. It is the ECB's primary tool in keeping the euro's inflation rate under control.

Eurozone output shrank 0.3 percent in the fourth quarter and is expected to have contracted again in the first quarter. Worse, several leading indicators suggest that weakness may continue into the second half of the year and defy the ECB's prediction of a moderate recovery.

While growth predictions darken, borrowing costs for Spain and Italy remain high, fueling doubts about their ability to avoid a financial collapse that could strain or exceed the eurozone's ability to bail them out.

The ECB steadied financial markets with two massive handouts of cheap credit to banks totally just over (EURO)1 trillion ($1.3 trillion) in December and February. The central bank says it is still analyzing the effects of the loans so analysts think another handout is unlikely to happen soon, if at all.

The bank could reactivate a dormant program to purchase government bonds in the secondary market in an effort to drive down borrowing costs for indebted governments. However, the program had limited effect when it was last used and has been criticized by several top ECB officials who say a central bank rescue simply undermines politicians willingness to reduce spending.

[Associated Press; By DAVID McHUGH]

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