ECB extends bank loans, holds fire on bond buying

The ECB left its key interest rate at a record low of 1.0 per cent but said it would extend cheap emergency funding for the commercial banks through the first quarter of 2011.

Crucially, the ECB said it would also continue to buy government bonds to help ease pressure on a growing list of eurozone countries -- Belgium, Greece, Ireland, Italy, Portugal and Spain -- but gave no indication it would increase its purchases, as the markets had hoped.

"The ECB chose a compromise," ING senior economist Carsten Brzeski noted, a view echoed by many other analysts.

The central bank also released new growth forecasts that included an upward revision to 1.7 per cent for 2010, but it warned: "The risks to this economic outlook are tilted to the downside, with uncertainty remaining elevated."

The 16-nation eurozone economy was forecast to grow around 1.4 per cent in 2011 and 1.7 per cent in 2012. Inflation estimates came in at 1.6 per cent for 2010, 1.8 per cent for 2011 and 1.5 per cent for 2012.

Investors had sought signs from ECB head Jean-Claude Trichet that the bank was ready to take fresh measures to tame a debt crisis now threatening Spain after engulfing Greece and Ireland.

"There is a risk of a full-blown crisis whereby contagion affects all peripheral countries and possibly moves to some core countries," said Marie Diron, senior economist at Ernst & Young.

IHS Global Insight's Howard Archer said that "the ECB's extension of its emergency liquidity measures will help matters but it is really the minimum of what was expected or hoped for by the markets."

Trichet refused to be drawn on specifics regarding the bank's controversial purchases of government bonds but he left the door open to more and possibly at higher levels.

"The SMP programme is ongoing," Trichet said in a reference to the ECB's Securities Markets Programme. "I repeat, the SMP programme is ongoing."

The ECB was "constantly alert," he added, to "acute tensions" on bond markets, a remark taken to mean it might increase its bond purchases as part of a policy of ensuring that its monetary policy is effective.

Trichet stressed that the bank's policies were not the same as Quantitative Easing, the direct creation of new money adopted by the US Federal Reserve and Bank of England to bolster economic growth.

"It is not quantitative easing," Trichet insisted. "We are withdrawing all the liquidity that we are injecting" into the eurozone economy.

Before the ECB meeting, there was speculation that the ECB could expand its bond purchases massively, up to one trillion euros or more.

So far the ECB has bought some 67 billion euros of government bonds from the commercial banks but it has offset all its purchases in full by taking in an equal amount in deposits from the banks -- meaning that the net effect is that no additional money is created in the economy.

The Fed and BoE have, in contrast, not offset their bond purchases, meaning that the cash handed over to the banks is immediately pumped into the economy.

Hopes the ECB would signal more help for banks and governments eased market pressure on Spain on Wednesday but Madrid still had to offer sharply higher rates of return at a sale of 3-year bonds in an auction on Thursday.

Spain is the fourth biggest eurozone economy and a debt crisis there would represent a substantial worsening of a situation that has already sent shock waves around the globe.

Commerzbank economist Michael Schubert concluded that the ECB had effectively postponed a decision on winding down exceptional support measures "at least until mid-April 2011."

Changes to its main interest rate are not expected until even further into next year.

"The sovereign debt crisis has once again delayed the ECB's exit strategy," ING's Brzeski said, warning that "turbulences on bond markets are not likely to calm down quickly."