ECB keeps rates on hold amid credit, euro tension

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VIENNA, Oct 4 (Reuters) The European Central Bank kept its main interest rate at 4 percent on Thursday, in line with economists' expectations that rates would stay on hold due to financial market turmoil and the strong euro.

ECB President Jean-Claude Trichet will explain the decision in a news conference at 1230 GMT, and analysts are looking for guidance about the economic outlook since a credit squeeze has pushed up the market rates which commercial banks must pay for funds.

The euro's record strength against currencies of its main trading partners -- and concern expressed by France, Italy and Belgium -- may also prompt Trichet to say something about exchange rates which is more revealing than his usual reference to past statements made by the Group of Seven nations.

Trichet will speak in Vienna, where the ECB Governing Council held one of its two meetings a year outside the bank's Frankfurt headquarters.

All 66 economists polled by Reuters had expected the ECB to leave rates unchanged, with most reasoning that the strong euro and higher risk premia on interbank lending have a dampening effect on the economy tantamount to one or more ECB rate rises.

''If you look at the past four weeks in terms of news flow, it was more or less all disappointing,'' said Luigi Speranza, euro zone economist at French bank BNP Paribas.

''The uncertainty they talked about last month hasn't disappeared, and there is increasing evidence that the slowdown in the global economy is hitting the domestic economy. What was a postponement now looks like rates on hold for an extended time,'' he said.

Until problems in the U.S. subprime mortgage market prompted a global credit squeeze in August, the ECB had looked set to raise rates to 4.5 percent by the end of the year. Now most economists expect it to stay on hold until the end of 2008.

The credit squeeze forced the U.S. Federal Reserve to cut interest rates by a surprise half percentage point to 4.75 percent last month, and earlier on Thursday the Bank of England kept rates steady at 5.75 percent after being on a tightening path earlier in the year.

The European Commission said on Thursday that growth fundamentals remain strong in the 13-nation euro zone but that risks have increased because of the market turmoil and U.S.

economic slowdown.

The euro and interest rate futures were steady after the decision.

FOCUS ON GROWTH AND EURO Economists are keen to see if Trichet gives a less optimistic growth outlook than last month, for example by naming currency volatility as a risk to growth.

The euro has touched a string of record highs against the dollar in recent days, and Germany's VDMA engineering association said on Thursday this was hurting business. On Monday Trichet said he ''noted with extreme attention'' that the United States had previously said a strong dollar was in the U.S. national interest.

Dutch bank ING said it expected Trichet to go further than his usual reference to the G7 statement but stop short of describing currency moves as ''brutal'', language he used in January 2004.

Overall economists expect the ECB to move closer to a neutral, wait-and-see stance and away from the tightening bias expressed at the last rate meeting.

But inflation has edged above the ECB's 2 percent ceiling for the first time in a year. With a further acceleration expected due to high food and oil prices, the central bank will still express concern about price risks.

''While upside risks to inflation are likely to be stressed again, downside risks to growth will be emphasised as well, so that the net outcome will likely be a sort of move toward a more neutral bias,'' said Aurelio Maccario, economist at Italy's UniCredit.

The Governing Council is likely to describe monetary policy as still being ''on the accommodative side'', and analysts are keen to see if it sticks with last month's statement that policymakers will monitor all developments ''very closely''.

Although economists see an ECB rate cut in the next six months as generally an outside chance, some say the odds will increase if the euro rises further or growth slows sharply.

Growth in the euro zone's services economy suffered its biggest slowdown in at least nine years in September as the market turmoil hurt business and new orders, the Eurozone Services Purchasing Managers' Index showed on Wednesday.

Manufacturing growth slowed to its weakest pace in nearly two years and business confidence is at its lowest level in more than 1-1/2 years in Germany, the region's largest economy.

Slower growth may ease inflation pressures, and the strong euro is curbing dollar-priced oil costs, which have fallen back from record highs above per barrel.

But higher food prices, especially for dairy products and grains, have a disproportionate effect on consumers' inflation perceptions, which are already at the highest in almost a year.

REUTERS KR VC2021

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