The European Central Bank kept euro zone interest rates at 1 percent as expected on Thursday, teeing up what should be an upbeat news conference with the bank's President following a strong run of economic data.
With inflation in the 16-country euro zone undershooting and the region's post-crisis economic recovery still in a delicate phase, the decision to keep rates at a record low for the 15th month running was widely expected.
The decision to keep rates on hold was an obvious one, said J.P. Morgan economist David Mackie. We don't have a rate rise in our forecast horizon, and our horizon goes to the end of 2011.
ECB President Jean-Claude Trichet should have a spring in his step following the strong run of summer data, signs that the worst of the debt crisis is over, and evidence that recent bank stress tests have been given the thumbs-up.
I don't think he'll be sounding over-confident but he will certainly be pleased with how things have gone over the last month. It would be hard for him not to, said Mackie.
Trichet is also expected to reaffirm that rates remain appropriate, bolstering the consensus that they will remain on hold well into next year.
The news conference is set to start at 1230 GMT (8:30 a.m. EDT). It will be studied for signs of whether the ECB sees the euro zone economy maintaining recent signs of improvement.
Trichet should be in a sunny mood, said Societe Generale economist Klaus Baader. The data have continued to improve and the euro zone's sovereign debt troubles have moved out of the spotlight.
SUPPORT MEASURE HINT
ECB watchers are also hoping Trichet gives an early hint on whether banks will continue to have access to unlimited ECB cash for the rest of the year, past the current deadline of October.
The decision is more likely to be held back until next month but prolonging so-called 'full allotment', especially for longer-term three-month lending operations, would reassert downward pressure on money market rates, which have been rising since the end of March.
The preannounced three-month operation in September will be the last with full allotment. Subsequent three-month operations will go back to being variable-rate tenders, said Baader, who expects the ECB to keep unlimited weekly and month-long loans on offer well into next year.
Money market rates are a vital part of the ECB's current monetary policy strategy. By pumping banks with cash during the crisis, bank-to-bank charges fell well below the 1 percent mark suggested by the ECB's benchmark rate.
The recent upward trend in market rates has been driven by banks themselves, a point Trichet is expected to stress during the news conference, but analysts point out that it represents an effective interest rate rise.
Analysts say better-than-expected bank stress tests results have already sparked improvement on bank-to-bank lending markets, with higher turnover in short-dated loans, in a hopeful sign that banks can cope with less ECB funding.
In contrast to U.S. indicators, which suggest post-recession recovery there may be flagging, data in the 16-nation euro zone has continued to outperform since the ECB's July meeting.
That divergence has opened a gulf between the ECB and the Federal Reserve, which has publicly toyed with a return to stronger stimulus. The Bank of England has done the same. It too kept rates on hold on Thursday.
Euro zone economic morale hit a 28-month high in July, European Commission data showed last week, while consumer confidence is now at the highest level in more than two years.
Manufacturing growth, the main driver behind the recovery, also accelerated thanks to a strongly-performing Germany which on Thursday reported a 3.2 percent leap in manufacturing orders in June.
However, economists say growth may falter when government spending cuts hits. Ireland's central bank warned last week that euro zone growth was expected to slow in H2 and risks to the outlook were on the downside.
Recent strength of the euro is also expected to drag. It has risen almost 10 percent against the dollar since June.
There have been some negative data. An ECB lending survey showed banks expect to continue clamping down on lending. Retail sales were also flat in June, pointing to lacklustre consumer spending that could undermine the recovery.
But another signal that the ECB is confident about the outlook is that it has slowed its government bond buying programme to a near halt, leading many to believe the purchases will soon be phased-out.
We do not expect the ECB to announce an end of this facility. However, unless stress in periphery markets re-emerges, the effective use of the securities market programme (bond buying) is likely to go to zero quickly, said Citi economist Juergen Michels.
(Reporting by Marc Jones; Editing by Mike Peacock)