The European Central Bank extended its liquidity safety net for vulnerable euro zone banks into next year, delaying its exit from crisis measures for now as it urged caution about the economic recovery.
The ECB left rates at a record low of 1 percent for the 16th month in a row on Thursday and said policy remained accommodative as the region battles with an uneven recovery and concerns about bank vulnerability.
ECB staff raised economic growth forecasts but President Jean-Claude Trichet said risks were to the downside and the recovery would be moderate with uncertainty prevailing.
We have to remain cautious and prudent. We don't declare victory, he told his monthly news conference, although a double-dip recession was not on the cards.
The ECB extended its promise to lend banks unlimited one-week and one-month funds until at least January 18, keeping liquidity flush through the tense end-of-year period in a move which should keep market rates low.
It will also offer unlimited funds at three-month operations until December although the cost of these will not be fixed in advance, rather indexed to the ECB's policy rate.
Although Trichet said the decision should not be taken as a signal the ECB was preparing to raise rates, analysts said it was positioning itself to wind back liquidity support in early 2011 as a precursor to raising policy rates.
The return of accommodative to describe policy, a word which has been absent from the introductory statement for three years but which became a key communication during the last tightening cycle in 2006 and 2007, also raised eyebrows.
It's not a finger on the trigger but the safety catch is off, Societe Generale economist James Nixon said.
I think early next year they are going to progress onto the next stage of their exit strategy and in the second half, they will have their finger on the trigger.
While the decision on rates was unanimous, Trichet said the decision on liquidity supplies was by consensus -- usually a sign of some dissent on the 22-member Governing Council.
The extension maintains a lifeline for banks in countries like Spain, Ireland and Greece, although Trichet brushed off questions about the gap in performance between core countries such as Germany and those struggling on the euro zone rim.
Borrowing from the ECB by banks in these countries has hit record highs in recent months even though total lending has fallen about a third since July.
Ratings agency Standard & Poor's cut Ireland's credit rating last week to AA- after the country's banking crisis bill was revised upwards.
ECB staff upgraded growth forecasts on the back of a strong second quarter, when Germany grew at its fastest rate since reunification and more than twice as fast as the euro zone average, confirmed at 1.0 percent on Thursday.
But Greece is still in recession and Portugal and Spain managed just a tenth of Germany's growth rate.
Staff see euro zone growth of about 1.6 percent this year, from about 1 percent in June, and about 1.4 percent in 2011, from 1.2 percent.
The quarterly forecasts also showed inflation under control, with consumer price gains seen at about 1.6 percent in 2010 and 1.7 percent in 2011 -- below the bank's 2 percent ceiling.
Euro zone inflation moderated to 1.6 percent last month but there are some signs of pressure, notably Germany's powerful steelworkers union demanding a 6 percent pay rise.
Expectations of continued ECB liquidity largesse have pushed market interest rates down from 12-month highs over the last month, although pressure points remain.
But turnover in overnight money markets fell back in August and many banks still prefer to deposit excess funds back at the ECB rather than lend them on to counterparts.
The ECB also moved on Thursday to ensure banks cope with liquidity cliffs at the end of September and December, when the repayment, or roll-over, of hundreds of billions of euros borrowed in 12-, six- and three-month funds, is due.
It will offer three special short-term cash injections towards the end of October, November and December to help banks at risk of getting caught short of funds.
The ECB is not alone in dragging its feet towards the exit. Sweden's Riksbank hiked rates on Thursday to 0.75 percent but cited weak growth in the euro zone and United States as a risk to the outlook. The Bank of Japan has boosted its cheap loan scheme and the Federal Reserve took steps towards further stimulus by reinvesting maturing mortgage-related securities.
(Writing by Krista Hughes, editing by Mike Peacock/Ruth Pitchford)