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ECB set to ring in New Year with policy on hold

The European Central Bank on Thursday left its key interest rates unchanged at its first policy meeting of the year, despite current volatility on the world's financial markets owing to concerns about the slowing Chinese economy.

[FRANKFURT] The European Central Bank will not introduce new policy measures at its first meeting of 2016 on Thursday but is expected to keep the door open for more stimulus later, in the face of recent financial market turmoil, analysts said.

"We expect the ECB to leave its deposit rate and asset purchase programme unchanged," said RBS economist Andrew Cates.

"Further easing initiatives would probably damage the ECB's credibility coming so soon after last month's package of measures. And while the recent bout of financial market turmoil and soft inflation data have strengthened the case for bolder action, forward looking survey data and the ECB's recent lending survey in contrast have been more respectable."

At its December meeting, the ECB cut its key "deposit" rate by a modest 0.10 percentage point to minus 0.30 per cent and extended the length of its bond purchases by six months to March 2017.

At the same time, the ECB held its other two key rates - the refi and marginal lending rates - unchanged at 0.05 per cent and 0.30 per cent respectively, where they have been for more than a year.

Nevertheless, the measures were widely seen as too timid, particularly as comments from top ECB officials had fuelled speculation beforehand that it was preparing to aggressively ramp up its bond-buying programme and further loosen monetary policy to inject some vim into a eurozone beset by years of torpid growth and stagnant inflation.

In the wake of the widespread disappointment over the moves, ECB watchers suggested that any sudden announcement of new measures this week would dent the central bank's credibility.

But ECB chief Mario Draghi "will nevertheless surely indicate that the door is still open to further easing in the coming months," Mr Cates said.

"Market-based inflation expectations are still far too low for comfort and could become even further unhinged should the oil price continue its descent. Downside risks to the growth outlook have obviously increased as well as a result of the recent financial market instability." Oxford Economics economist Ben May agreed.

"Markets will be looking for signs as to whether the renewed fall in the oil price, ongoing concerns about China and financial market weakness will see the dovish contingent of the governing council regaining the upper hand," he argued.

ING DiBa economist Carsten Brzeski suggested that as Draghi "already had problems uniting the ECB for the December decision, we believe the ECB will keep dry the little powder it has left - at least for this week." On the basis of the economic data, there was "no reason for the ECB to re-assess its monetary stance again this week," Mr Brzeski said.

"Still, the risks for the eurozone have not disappeared," Mr Brzeski argued.

"On the contrary, the latest market turmoil, continued concerns about the Chinese economy, adverse effects from low oil prices and recent worries that the US Federal Reserve might have jumped the gun in December have clearly increased the external risks for the eurozone," he said.

In an interview with the financial daily Boersen-Zeitung, the ECB's former chief economist Otmar Issing suggested the governing council should re-think its timeframe for steering eurozone inflation back up to the central bank's target of close to but just under 2.0 per cent.

The ECB's goal is to reach that target "in the medium term." But "there is a lot to be said for pushing back that time horizon a fair bit," Mr Issing said.

If the timeframe is too short and a central bank does not achieve its inflation target by then, it could be easily seen as failure, he continued, criticising the communication of central banks in general.

The ECB's deputy president Vitor Constancio conceded that mistakes had been made in communicating the bank's intentions in December.

It was "difficult enough to calibrate monetary policy correctly. But it is even more difficult to fine-tune market expectations. Sometimes our statements are over-interpreted," Mr Constancio said in a newspaper interview at the end of last month.

According to the minutes of the December meeting, the 25-member governing council appears to be divided about the need for more policy action.

The minutes said that "some" members had argued "that the existing policy measures ... should be given time for them to unfold their full effect ... before adopting further monetary policy measures" - a point often made publicly by Germany's central bank chief Jens Weidmann.