[ForexNews]

The ECB Governing Council, as universally expected, left the official interest rates unchanged today. The following press conference illustrated that for the Governing Council a pattern of gradualism continues. Although some continue to pencil in a further 25bp cut in the main refinancing rate later in 3Q, whether this materializes is a very open question. Above all, the inflationary environment is likely to be sufficiently subdued for the ECB to be able to maintain ultra-low interest rates for many quarters to come. As well, to the extent that it feels the need to undertake further monetary stimulus, the Governing Council now clearly has the option of undertaking larger amounts of asset purchase (its current covered bond purchase scheme, at €60bn, is only 0.7% of euro area GDP, compared with up to 12% of US GDP under the Fed's current plans, and 10% of UK GDP for the Bank of England's plans.

In the Statement, the Governing Council endorsed a particularly downbeat set of staff projections (a midpoint for real GDP this year at -4.6%, revised down from -2.7%, and for 2010 at -0.3%, revised down from flat). These projections are rather more pessimistic. Meanwhile, the inflation projection for 2009 was revised down only very slightly, to 0.3% from 0.4%, while the 2010 projection was unrevised at 1.0%. The Council appears to be wrestling with divergent patterns: on the one hand, higher commodity prices present a somewhat more adverse trade-off between activity and inflation, while the labor market situation is clearly a still-growing concern; however, there are some tentative hope found in the latest confidence survey data.

The technical purchase details for the covered bond purchase programme disclosed today were broadly as expected. The €60bn purchase programme would happen from 1 July through end June 2010. Of note, the plan will include the purchase of covered bonds backed by public sector assets, as well as those backed by private sector assets. This is a somewhat controversial issue for the Council to have decided upon. The decision probably reflects a growing concern that it may become tougher for state and local tiers of government to obtain sufficient financing from the banking sector and markets, but it does shift the ECB a notch further in the direction of outright of potential direct public sector asset purchases.

Concerning any possible future expansion of this asset purchase programme, ECB President Trichet refused to give a signal, saying that the €60bn plan was all that the GC has agreed ("we should not in my opinion say anything which creates expectations"), and that "there is absolutely no other decision at this stage."

Mr Trichet was pushed three times on whether the effect on the ECB's money base of the covered bond purchases would be sterilized or not. He replied that the Governing Council "expects automatic stabilization." However, when asked what would happen if banks continued to borrow the same amount at the ECB's refinancing operations (and therefore that the CB purchases would be resulting in a net expansion in the monetary base), Mr Trichet replied, "We will look at it very fully, and if it is not the case, we will take appropriate measures." However, he did not spell out what such measures would be.