European central bank prepares way for further policy move next month

The European Central Bank held its key rates steady Thursday, butpresident Mario Draghi gave a strong hint that the bank is ready to act next monthto avert looming deflation.At its monthly meeting, held in Brussels this time instead of the usual venue ofFrankfurt, the ECB's governing council kept the key interest rate at the current all-time low of 0.25 percent for the seventh month in a row.The announcement sent the euro spiking to its highest level in two and a half years.Draghi explained that all the available information pointed the eurozone's currentmodest recovery would continue.However, the stubbornly low level of inflation in the single currency area is fuellingfears of possible deflation, a destructive downward spiral of falling prices.Until now, the ECB has always insisted it sees no such dangers.But in a surprise departure from the bank's previous policy of never pre-committingon interest rate moves, Draghi said the decision-making body was now sufficientlyconcerned to take more action. The governing council was "dissatisfied" with the current path of inflation and was"not prepared to accept it as a fact of nature," Draghi said.As a result, the governing council "is comfortable with acting next time," he said.But he added that "we want to see the staff's projections that will come up in earlyJune."The ECB is scheduled to publish its latest updated growth and inflation forecastsnext month.- Geopolitical uncertainty -There was a consensus among council members that area-wide inflation must notremain at the current low levels, he explained.Consumer price inflation in the eurozone was at 0.7 percent in April, up from 0.5percent the previous month but well below the ECB's target of 2 percent.Economic recovery was so far slow and tepid, and there were several downside risks, Draghi noted.These included geopolitical uncertainty connected with the crisis in Ukraine.The strong euro, too, which is changing hands at almost $1.40, was also of "seriousconcern" for the central bank, Draghi noted.The ECB has no target for the euro-dollar exchange rate, but a rising euro "in thecontext of low inflation and weak economic growth was a cause of serious concern,"Draghi said.ECB watchers were taken by surprise by Draghi's forthright comments."What started off as a rather dull meeting developed into a very exciting pressconference," said ING DiBa economist Carsten Brzeski.He saw it as "a final goodbye" to the mantra of Draghi's predecessor Jean-Claude Trichet that the ECB "never pre-commits".Brzeski insisted that a move next month was not yet a done deal."Every next meeting will have new and more information than the previous one.However, with his comments on the exchange rate and hints at possible June action,raghi has pushed the ECB into a corner from which it will be very hard to escape,"the analyst said- 'Limited real effect' -Berenberg Bank economist Holger Schmieding said that if the ECB does act in June,"it would probably not make a big difference".Unless the ECB were to surprise markets with full-scale quantitative easing, "the ECBdecision in June will likely herald a modest rebound rather than a further fall inbenchmark yields in the eurozone," he said.Quantitative easing is the large-scale purchase of government bonds as practised byUS Federal Reserve.Tom Rogers of EY Eurozone Forecast also said that a rate cut next month "wouldprobably have limited real effect".But "we agree this would be the right move, in that it would at least underline theECB's credibility (and) temporarily ease upward pressure on the euro.Commerzbank economist Joerg Kraemer similarly said that he "does not want topredict a rate cut next month just yet."The ECB "is strongly influenced in its decisions by monthly economic data, whichare very difficult to predict accurately," he said."Furthermore, sentiment within the ECB's governing council frequently changes veryquickly."IHS Global Insight analyst Howard Archer suggested the ECB could take its depositrate -- currently at zero percent -- into negative territory for the first time."While the ECB has previously seemingly baulked at taking its deposit rate intonegative territory, it now appears to believe that a full lowering of the interest ratecorridor would be most effective rather than just trimming the refinancing rate," hesaid.