MercoPress. South Atlantic News Agency

Euro zone benchmark rate unchanged, but ECB needs to absorb extra liquidity

European Central Bank President Jean Claude Trichet: “the market working a little bit better”

European Central Bank President Jean Claude Trichet said Europe is recovering faster than forecast and money markets are improving, paving the way for the ECB to phase out liquidity tools used to fight the financial crisis.

“The available data for the third quarter are better than expected,” Trichet told reporters in Frankfurt Thursday after the ECB’s Governing Council kept its benchmark at a record low of 1%.

“The market is working a little bit better.” The ECB main rate is still “appropriate,” he said, indicating officials see no immediate need to tighten policy.

The Euro region’s economy and financial markets are improving, leaving Trichet with the challenge of indicating how the ECB will scale back its supply of unlimited cash to banks without threatening the recovery or roiling investors.

Investors are indicating that the worst is over for the Euro area. The single currency has rebounded 10% against the dollar since June 7, Europe’s Stoxx 600 index s jumped 11% in July and relative yields on the region’s junk bonds are set to fall below their U.S. counterparts for the first time since June 2008.

The extra yield investors demand to hold speculative-grade corporate bonds issued by European companies instead of benchmark government debt has dropped to 656 basis points compared with 649 basis points in the U.S., Bank of America Merrill Lynch indexes show.

As the euro-area economy gathers strength and the region’s bond market shows signs of stabilizing, the ECB is running down the emergency debt purchases introduced in May. The next step may be to wean banks off unlimited liquidity, which it currently offers for periods of up to three months at its benchmark rate.

Banks can borrow as much money as they need for seven days and one month until at least Oct. 12. It will offer unlimited cash for three months until September. The ECB last year scaled back 12- and 6-month loans introduced after the collapse of Lehman Brothers Holdings Inc. in 2008.

The risk for policy makers is that they tighten policy too soon just as government austerity measures to reduce budget deficits threaten growth.

Trichet said the economy will only expand at a “moderate, but still uneven pace in an environment of uncertainty” and that growth in the second half of the year may be weaker than the second quarter.