European Rates Unchanged

The Bank of England surprised markets on Thursday with a significant expansion of its program to boost the money supply and support growth, even as it and the European Central Bank kept official interest rates steady at record lows.

The move by the British central bank to boost its so-called quantitative easing program by 50 billion pounds ($84 billion) to 175 billion pounds ($295 billion) garnered the main attention in Europe, underscoring official caution about recent signs of an economic recovery.

As the ECB shied away from announcing any new measures on "enhanced credit support," the ECB's version of quantitative easing, the British pound lost almost two cents against the U.S. dollar while European government bonds rose — reversing an earlier loss — after the announcement in Britain.

The Bank of England noted recent conflicting data on the economy, saying financial conditions were "fragile" and that growth in the money supply "remains weak" as it explained its decision.

RBS economist Stephen Boyle said the bank's nine-member monetary policy committee had "decided it is better to be safe than sorry."

The British central bank turned to the quantitative easing program in March after almost running out of room to cut interest rates. Under the program, the central bank buys financial assets such as bonds from banks and pays for them by crediting the banks' account at the Bank of England, in effect creating new money.

As expected, it held rates steady at 0.5 percent on Thursday while the ECB stood pat at 1 percent. Economists expect both banks to keep interest rates at their current lows for some months.

In Prague, the Czech Republic central bank had more leeway, cutting its base rate by a quarter percentage point to a new record low of 1.25 percent.

Recent economic data in both the euro zone — a bloc of some 320 million people comprising nearly 17 percent of the world's output — and Britain have suggested early signs of an economic turnaround.

In Britain, the housing market and the key services and manufacturing industries have all shown signs of improvement in recent months. Similarly, German industrial orders recorded another strong month in June, advancing 4.5 percent and led by demand from other European countries, according to figures out Thursday.

"What I observed, in general, is that the overall mood is, right or wrong, today a little bit better than it was before, and not surprisingly because there have been a number of surveys that were a little bit better, some hard figures that were better," ECB president Jean-Claude Trichet told reporters in Frankfurt.

Trichet added that the "pace of contraction is clearly slowing down," and that the bank expects a phase of stabilization next year followed by a gradual recovery.

But concerns remain. Trichet repeatedly added that the outlook remains very uncertain.

"As far as we are concerned, and we can see, we are very prudent and cautious," he said.

The Bank of England said the recession had proved deeper than previously thought, reflecting data out last month showing that the British economy contracted by twice as much as economists had forecast in the second quarter — gross domestic product shrank by 0.8 pecent between April and June.

European Union statistics last week showed unemployment in the euro zone countries rose to a level not seen in a decade and consumer prices slipped more than expected.

"On the one hand, there is a considerable stimulus still working through from the easing in monetary and fiscal policy and the past depreciation of sterling," the rate-setting committee said in a statement accompanying its decision.

"On the other hand, the need for banks to continue repairing their balance sheets is likely to restrict the availability of credit, and past falls in asset prices and high levels of debt may weigh on spending."

Britain's banks are still suffering from their losses in the financial crisis and government officials say they are too tight with credit for businesses despite getting government bailouts.

Trichet suggested that banks needed to do more to strengthen their capital bases "and where necessary, take full advantage of government measures to support the financial sector, particularly as regards recapitalization."

The conflicting data had left economists divided ahead of Thursday's announcement about whether the Bank of England would expand its quantitative easing program.

Halting the asset buying program too early could prolong Britain's worst recession in decades, but pumping too much money into the economy raises the risk of an inflation headache down the road.

Trichet said the ECB's decision in May to buy euro60 billion ($86.4 billion) in covered bonds has been warmly received, with the bank revealing that it has so far spent euro5.1 billion through the ongoing program.

The ECB said that buying the bonds from commercial banks, considered a relatively safe way to provide lenders with more cash, had somewhat revived the covered bond markets from a near standstill in September 2008.