updated 7/1/2004 9:40:30 AM ET 2004-07-01T13:40:30

The European Central Bank decided to leave its key interest rate unchanged Thursday as it sorts through mixed signals about future growth in the 12 countries using the euro currency — even as central bank rates are on the rise in the United States.

The ECB's 18-member governing council kept the main refinancing rate at 2 percent at its monthly rate-setting meeting. The rate has been at that level for 13 months.

The decision came a day after the U.S. Federal Reserve raised a key lending rate by a quarter percentage point amid more robust U.S. growth.

Bank president Jean-Claude Trichet faces the dilemma of sluggish growth and inflation worries. The bank has stuck with its forecast of stronger growth this year and next after only 0.4 percent last year — an upbeat scenario that economists say dictates an eventual rate increase to squeeze inflation out of a growing economy.

But economic news has cast a shadow over the recovery. The German Ifo Institute's key index of business sentiment showed an unexpected drop last week, the second month in a row.

And consumer spending remains weak. A faltering recovery could be endangered by a rate increase, which would raise borrowing costs for business, while a cut could worsen inflation.

Inflation ran at an annual 2.4 percent in June in the euro countries, above the ECB's guideline of "close to, but below" 2 percent. The bank says it expects the increase to be temporary and that inflation remains under control — but has indicated it sees greater potential inflation risk from higher oil prices.

The combined concerns over growth and inflation have left the bank firmly entrenched in a wait-and-see stance.

"The problem, the reason they do nothing now, is of course the uncertainty," said Commerzbank economist Michael Schubert. "They are not certain whether the growth prospects in the euro area will prove to be sustainable."

Most economists expect the bank's growth predictions to come true, and that it will raise rates sometime next year. Schubert said that the U.S. Federal Reserve's decision Wednesday to raise its key federal funds rate to 1.25 percent from 1 percent — its first increase in over four years — confirms the ECB's outlook because it means the Fed believes the U.S. upswing is solidly established.

That, in turn, will help Europe's export-oriented economy. The U.S. economy grew 3.9 percent in the first quarter and has begun to add more jobs. More Fed raises are expected.

One wild card is how much the Fed's move will support the U.S. dollar, whose decline against the euro has raised fears it will hurt the euro-zone recovery by pricing European exporters out of the market against U.S. competitors.

Rising U.S. interest rates should pull investor money into higher-yielding U.S. assets; since investors must buy dollars to purchase U.S. assets, that would tend to drive up the dollar's exchange rate. The dollar's value against the euro has stabilized at a range between $1.18 and $1.23 for the past several months.

Some analysts think, however, it could eventually resume its slide, given that the Fed's move was widely expected and so could already be reflected by currency markets.

"I am convinced the current interest rate rise will support the dollar in the short term," economist Claudia Windt of Helaba Bank in Frankfurt said. "But in the middle term the dollar will continue to weaken."

Copyright 2004 The Associated Press. All rights reserved. This material may not be published, broadcast, rewritten or redistributed.


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