ECB holds rates to assess deflation threat

The European Central Bank left interest rates unchanged on Thursday, holding off policy action while it waits for new economic forecasts next month to assess the deflation threat facing the eurozone.
   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 the minds of the bank's policy makers.
   The ECB held its main rates at 0.25 percent, left the deposit rate it pays on bank deposits at zero and held its marginal lending facility - or emergency borrowing rate - at 0.75 percent.
   "Unchanged rates was our expectation today, though we suspect it may have been a close call and may disappoint some," said Nick Matthews, economist at Nomura.
   The euro rose after the ECB announcement and German Bund futures extended falls.
   Money market traders had expected no change in rates, nor any other steps to combat falling inflation or prop up the euro zone, a Reuters poll taken on Monday showed.
   The ECB is wary of inflation getting stuck in what ECB President Mario Draghi has dubbed a "danger zone" below 1 percent. The bank has vowed to keep rates at present or lower levels for an "extended period".
   The Governing Council met against the backdrop of turmoil in emerging markets which risks forcing the euro higher - a scenario that could put more downward pressure on prices.
   The emerging market ructions and January's inflation drop throw next month's ECB staff projections into sharp relief - a downward revision could prompt policy action. But first, markets will focus on Draghi's 1330 GMT news conference.
   "Draghi will now have to deliver some very soft words to meet the market's expectations," said Anders Svendsen, chief analyst at Nordea.
   A month ago, Draghi 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, which may make it reluctant to act too quickly. There might be only one more rate cut in its arsenal and even that would be smaller than the traditional quarter point.