ECB holds rates, lets crisis squeeze politicians

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By DAVID McHUGH, Associated Press

FRANKFURT (AP) — The European Central Bank withheld the stimulus of an interest rate cut Wednesday, keeping up the pressure on eurozone politicians to take decisive action — even as growth predictions worsened and fears intensified that Spain may need help bailing out its banks.

The 23-member governing council left its benchmark refinancing rate unchanged Wednesday at a record low 1.0 percent.

ECB President Mario Draghi cited economic growth forecasts for a gradual recovery this year in justifying the decision not to cut rates this time around. Rate cuts are supposed to help growth by lowering business borrowing cost. Some analysts, however, said the bank's expectations of only a 0.1 percent decline over the full year were overly optimistic.

Analysts say Draghi's hands-off stance Wednesday was meant to underline the need for action on restructuring the euro by the 17-country eurozone's divided and often slow-moving politicians. He has urged leaders to sketch in a vision of how the economies and financial systems of euro member countries can be better linked ahead of a June 28-29 summit where new ideas to save the euro are to be presented.

One reason for not cutting today "was possibly that the ECB sees current market tensions as a way of focusing politicians' minds on reform efforts," said Michael Schubert at Commerzbank.

Investors took the lack of new monetary stimulus in their stride, with most European stock indexes showing modest increases on the day.

Yet there is plenty to worry about in Europe. Investors are growing increasingly concerned that Spain will need outside help to bail out a banking system creaking under the weight of bad real estate loans. Greece, which has already stuck creditors with a debt write-down and taken two rounds of bailout loans, faces an uncertain future in the euro ahead of June 17 election. Voters may elect a government that rejects the painful cutbacks demanded by other eurozone countries in return for the bailout loans. If Greece rejects bailout terms, it could go completely bankrupt and be forced out of the euro.

Either a Spanish bailout or debt default, or a Greek exit could hurt growth in the United States and Asia by creating losses and fear among banks, which are key to the functioning of the global economy, and by hurting trade. Many U.S. companies get a sizeable part of their sales and profits from Europe so a recession there would impact companies and economies around the world.

Draghi's dilemma is between not doing enough to support a sinking economy, and acting now and taking the heat off politicians. In some ways, the ECB faces a situation similar to that of the U.S. Federal Reserve, which has cut rates to near zero and bought bonds to expand the supply of money in the economy.

Yet poor U.S. hiring figures from Friday have suddenly raised the prospect that the Fed too might have to take more steps to support the economy.

Several bank-watchers said the ECB's stated economic forecasts were too upbeat and that the bank will move soon. Schubert of Commerzbank predicted a rate cut in the next several months to 0.75 percent. Others saw a cut as soon as the July 5 ECB meeting.

Draghi, however, has left himself some room to maneuver, saying that "we'll monitor closely all the developments and we'll stand ready to act" if necessary. He also said some members of the 23-member council advocated a rate cut.

He included the possibility that things might be worse than the bank's forecasts had predicted, warning that there were "downside risks" to the forecasts. He noted that data from business confidence surveys "all point in one direction and this one is not upward. " However, other figures such as German growth — which came in at a strong 0.5 percent in the first quarter — were more upbeat, he said.

Draghi stressed that eurozone politicians have to come up with a long-term vision for overcoming the problems of the euro: "What we all expect is a clarification of this vision, a path toward this objective with all the conditions that have to be satisfied to achieve this objective."

Those measures could include tighter central controls on country's finances to keep them from running up so much debt; added measures to stimulate growth by reducing regulation and emphasizing spending cuts, not tax increases; and common borrowing in which countries would back up each other's debts to eliminate the risk of default.

The euro was launched in 1999 with one central bank but multiple governments, each with its own budget and approach to regulating the economy. The eurozone was unable to keep some countries from building up too much debt and becoming costly, inefficient places to do business.

On Wednesday European officials proposed a start on a new system of financial regulations that aims to keep bank failures from costing taxpayers billions and bankrupting governments. Because many European governments are already overburdened with debts, rescuing their failed banks risks bankrupting some of them. Ireland has had to ask for an international bailout for that reason and investors fear Spain may be next.

The banks, in turn, own huge amounts of their governments' bonds, which drop in value when investors lose confidence in the country's financial future. The result is that any fall in confidence in either the banks or the government tends to create a downward spiral requiring foreign financial aid.

Yet the banking measures will not take full effect until 2018. That means the pressure is still on the ECB as well as the politicians.

Marie Diron, senior economic adviser for Ernst & Young, said the ECB should have cut rates and that growth measures were welcome but "such measures take time and time is what the eurozone does not seem to have. "

Draghi also downplayed any idea that the bank might offer more long-term cheap loans to banks following two rounds that put €1.019 trillion into the banking system. Those loans have not taken their full effect in the wider economy yet , he said, and some of the eurozone's problems were beyond the reach of central bank action.

"There is plenty of liquidity in some parts... and shortages in other areas," he said. "Some of these problems in the euro area have nothing to do with monetary policy."

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