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ECB holds rates at record low, puts focus on March

European Central Bank (ECB) President Mario Draghi attends the monthly ECB news conference in Frankfurt January 9, 2014. REUTERS/Ralph Orlow
European Central Bank (ECB) President Mario Draghi attends the monthly ECB news conference in Frankfurt January 9, 2014. REUTERS/Ralph Orlow

By Sakari Suoninen

FRANKFURT (Reuters) - The European Central Bank left interest rates at a record low on Thursday but put markets on alert for a possible move in March, acknowledging that emerging-market turbulence could hit the euro zone.

Risks to the currency bloc's economy remain skewed to the downside, ECB President Mario Draghi said after interest rates were held at 0.25 percent, and inflation would be low for a protracted period.

"Developments in global money and financial market conditions and related uncertainties, notably in the emerging- market economies, may have the potential to negatively affect economic conditions," Draghi told a news conference.

"The reason for today's decision not to act has really to do with the complexity of the situation ... and the need to acquire more information," he said.

Draghi immediately put markets on alert for possible ECB action in March, when he said the Governing Council would have more information at its disposal, including new forecasts from the bank's staff that will extend into 2016 for the first time.

If emerging-market turmoil persists, a move is more likely next month. A downgrade in the ECB's staff inflation estimate - already at just 1.2 percent for 2014 - could prompt action.

"On balance, we think President Draghi signaled that the Council has effectively called 'time-out' on the rate cut debate, and decided to wait one month before deciding whether to take further action," said RBS economist Richard Barwell.

"On that basis, we too will postpone our rate-cut call from February to March, not cancel it altogether."

A sharp drop in euro zone inflation to 0.7 percent in January, well below the ECB's target of just under 2 percent, would have focused policymakers' minds, particularly since emerging turmoil could put further downward pressure on prices.

ECB policymakers are already thinking about what action to take, if they see the need. The discussion at Thursday's meeting focused on what could bring about a materializing of the downside risks that would prompt action, Draghi said.

Markets scaled back their expectations of future ECB easing as Draghi spoke, with the euro rising to $1.36 from $1.3493 before the news conference started. German Bund yields and euro zone money market rates also rose.

Draghi fended off suggestions that deflation in the euro zone was a grave threat, adding that inflation expectations remained firmly anchored. If that changes, a significant policy response would be likely.

"We are monitoring developments carefully and are ready to consider all available instruments," he said, adding that the bank was ready to "take further decisive action if required."

Money market traders had expected no change in rates, nor any other policy steps, a Reuters poll taken on Monday showed.

The Bank of England faces a different problem - trying to convince markets that resurgent growth will not require an early interest rate rise. It too left policy on hold on Thursday.

DANGER ZONE

The ECB is wary of inflation getting stuck in what Draghi has called a "danger zone" below 1 percent and vowed again to keep rates at present or lower levels for an "extended period".

An emerging-market selloff risks forcing the euro higher, which would put more downward pressure on prices.

Asked about coordinating monetary policy action to address emerging-market turmoil, Draghi said this could be difficult as central banks all have their own mandates. But it could be discussed, so long as mandates were not compromised, he said.

For now, economic recovery is intact, though still in its infancy. The euro zone's private sector logged its busiest month in 2-1/2 years in January, surveys showed on Wednesday.

"We must be extremely cautious about this recovery. It is still fragile and it is still uneven," Draghi said.

A month ago, he set out markers for further ECB action, pledging the central bank would take action if its inflation outlook worsened or money markets saw "unwarranted" tightening.

But the ECB does not have a lot of ammunition left to boost inflation. There might be only one more rate cut in its arsenal and even that would be smaller than the usual quarter point.

Short-term interest rate volatility has been another headache for the ECB.

To prevent spikes in market rates, the bank could choose to end the offsetting government bond purchases made when the euro debt crisis was raging, which would add about 175 billion euros ($236.82 billion) to the money markets.

Draghi said that was one option under consideration, but it was not discussed in detail at Thursday's meeting, when policymakers had a "broad discussion" about all instruments.

"No action in Frankfurt today, but the door to further steps remains wide open as headline inflation stays weak," said Berenberg economist Christian Schulz. "The March meeting in particular, when the ECB's inflation forecast for 2016 will be published, could be crucial."

($1 = 0.7390 euros)

(Additional reporting by Paul Carrel and Eva Taylor. Writing by Mike Peacock; Editing by Jeremy Gaunt, Larry King)

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