The European Central Bank sees intensified threats to the euro zone economy and will provide struggling banks with longer-term liquidity to ward off a new credit crunch, President Jean-Claude Trichet said on Thursday.
The ECB earlier kept rates unchanged at 1.5 percent at its meeting in Berlin, the last for Trichet before he hands over to Mario Draghi, currently Italy's central bank governor.
The economic outlook remains subject to particularly high uncertainty and intensified downside risks, Trichet told a news conference, offering a more gloomy prognosis than last month when he merely talked of downside risks.
That shift in rhetoric will encourage investors to believe a rate cut is not far away.
The ECB has raised rates twice this year and may have been swayed from going into reverse immediately by inflation hitting 3.0 percent last month, well above its target of close to but below 2 percent.
Inflation has remained elevated ... and is likely to stay above 2 percent in the months ahead but to decline thereafter, Trichet said.
The ECB's interest rate decision was in line with the results of a Reuters poll of economists in which 56 of the 76 economists questioned saw rates being left unchanged while 20 expected a decrease.
The Bank of England, in contrast, grasped the nettle on Thursday, announcing it would inject 75 billion pounds more new money into the flagging UK economy.
The ECB is now likely to prepare an interest rate cut within the next four months, by March at the latest, said Berenberg Bank economist Holger Schmieding.
Although the bank uses a well-defined set of key words in its monthly policy statements to flag rate hikes ahead, it has yet to establish a similar vocabulary for the way down, making Trichet's statements harder to interpret.
To help banks withstand a further worsening of the European sovereign debt crisis and growing tension in the interbank market, the ECB threw another lifeline to commercial banks by renewing offers to lend them one-year funding in two operations, this month and in December.
The Governing Council has decided to conduct two longer-term refinancing operations, LTROs, one with a maturity of approximately 12 months in October and the other with a maturity of approximately 13 months in December, Trichet said.
Extra-long 12-month liquidity tenders were first introduced in June 2009 and the first such offer attracted record-breaking use of 442 billion euros ($588 billion).
The European Union executive is drafting plans for member states to coordinate a recapitalization of banks, as regulators meet to check the capital buffers of stressed lenders they had granted a clean bill of health in July.
Over the past couple of weeks, concern about a possible default of Greece has grown and tension is building up in the money markets as banks grow increasingly wary of lending to each others.
Trichet also said the ECB would start buying covered bonds again, reopening the 60 billion euro program it ran between 2009 and 2010 by spending 40 billion euros over a 12-month period from November, buying in both the primary and secondary markets.
Covered bonds are bonds backed by assets such as mortgages and public sector loans and are perceived as safe and high-quality assets.
The provision of liquidity and the allotment modes for refinancing operations will continue to ensure that euro area banks are not constrained on the liquidity side, Trichet said. All the non-standard measures taken during the period of acute financial market tensions are, by construction, temporary in nature.
But he continued to draw the line at other crisis-fighting proposals including the idea of turning the European Financial Stability Facility (EFSF) bailout fund into a bank that can tap the ECB for funds.
The Governing Council does not consider it would be appropriate that the central bank would leverage the EFSF, he said.
(Additional reporting by Paul Carrel, writing by Mike Peacock)