European Central Bank: market volatility has increased

The European Central Bank said Wednesday it is prepared to "act accordingly" in light of renewed market volatility, a sign that instead of keeping its benchmark interest unchanged at 4 percent, it could actually lower it.

The bank did not explain why it issued the statement, a surprise that caught markets off guard and produced mounting speculation about what path the bank could take.

Instead, the ECB, which sets monetary policy for the 13 countries that the use euro, said it may take action at a meeting of its Governing Council on Thursday to "contribute to orderly conditions."

"Volatility in the euro money market has increased and the ECB is closely monitoring the situation," the bank said in an unexpected announcement. "Should this persist tomorrow, the ECB stands ready to contribute to orderly conditions in the euro money market."

Most analysts had believed the bank would lift its rate, but in the wake of market turmoil resulting from liquidity problems and the U.S. subprime mortgage crisis, they and the bank backpedaled from the likelihood of an increase to 4.25 percent.

If the bank does, in fact cut interest rates, it would mark a halt in its campaign of rate hikes begun in December 2005. Since then, the ECB has steadily lifted rates by a quarter of percent from 2 percent.

The bank's message had some market observers conjecturing that it may be poised to mirror a move by the U.S. Federal Reserve Bank and lower its own lending rate for overnight funds, its marginal lending facility.

That facility has stood 100 basis points more than the main refinancing minimum bid rate for years.

Within minutes of the ECB announcement, the overnight interbank lending rates dropped to 3.99 percent to 4.11 percent from 4.64 percent to 4.76 percent.

The bank's announcement came as EU Economic and Monetary Affairs Commissioner Joaquin Almunia told EU lawmakers in Strasbourg, France, that Europe's economy "should not be affected greatly by the recent ups and downs."

He said that Europe and the eurozone must remain "very vigilant" in the wake of a lending crisis even though its economy is in good shape and it should not suffer from the aftereffects of financial market fluctuations.

In Madrid, Spanish Finance Minister Pedro Solbes said he believed the ECB would halt its interest rate increases.

"I don't know what the ECB will do" at its meeting, Solbes told Cadena Ser radio station. "But it's fairly evident... that most of the rise in interest rates is over."

He said that the climate of uncertainty created by the U.S. subprime crisis was to blame.

"The latest data doesn't show that we have a problem on solvency of financial institutions. What we have is a problem of liquidity, but not because people don't have money, but because there is uncertainty and distrust," he said.

Just two weeks ago, the bank appeared sure to lift its key refinancing rate by a quarter point, despite concerns about a credit crunch triggered by fears of losses from U.S. subprime credit mortgages.

But after injecting more than EUR211 billion (US$288 billion) in emergency funds into money markets, and amid unease on stock markets, analysts say the bank may hold off for another month or more before lifting its interest rate.

Thirty-nine out of 51 private-sector banks polled by Dow Jones Newswires forecast that the ECB will now leave the refinancing rate at 4 percent on Thursday. Thirty-three of them predicted that the rate would hit 4.25 percent by the end of this year.

"Maintaining the status quo seems to be the most probable scenario, since it would give the central bank more time to judge the financial situation and its impact on growth and inflation," BNP Paribas economists wrote in a note to investors.

Last week, ECB President Jean-Claude Trichet stressed that he was not "pre-committed" to raising rates and that earlier comments - interpreted as a hint that the bank would increase them on Sept. 6 - had been made before August's financial markets volatility.