Draghi holds rates, but further cuts expected

The president of the European Central Bank, Mario Draghi, warned yesterday that the economic outlook for the eurozone remains "subject to high uncertainty and substantial downside risks", in an indication that further interest rate cuts by the Frankfurt-based lender of last resort are on the way.

The ECB's governing board yesterday kept rates on hold at 1 per cent, but analysts said Mr Draghi's acknowledgement of threats to the economy signalled that rate reductions are likely in future.

"The ECB seems to be leaving the door very much open to further interest rate cuts," Howard Archer of IHS Global Insight said. "Our suspicion is that the eurozone will suffer further economic weakness over the early months of 2012 at least, and we expect the ECB to respond cutting interest rates further."

That view was shared by Holger Schmieding of Berenberg Bank, who predicted that the ECB will cut rates to 0.75 per cent if tensions in the eurozone financial system escalate in the coming weeks.

However, there were signs of bond market pressures easing yesterday, as Spain and Italy saw their borrowing costs fall in separate debt auctions to raise a combined €22bn (£18bn).

Mr Draghi said the ECB has successfully eased the pressures on the Continent's banking system through its provision of €489bn in three-year loans to banks last month.

"The more time passes... the more we see signs it has been an effective policy measure", he said.

"This decision has prevented a credit contraction that would have been... much more serious".

Meanwhile the Bank of England also kept rates on hold yesterday, as a report showed that UK industrial production had dropped by a sharper than expected 0.6 per cent in November.

The Bank's Monetary Policy Committee decided not to extend its £275bn bond purchasing scheme, although it said the stimulus programme will be kept under review. Analysts said they expected a further increase in bond purchases to be announced in the coming months.

The fall in UK industrial production was driven by drops in oil, gas and electricity output.

There was also a 1 per cent fall in Britain's manufacturing output on the previous month.

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