Investors with substantial holdings in European markets may have to sit tight, as any meaningful economic recovery still appears to be quite distant.

The European Central Bank left its benchmark interest rate unchanged at 1% for the 16th consecutive month on Thursday, in a decision that was widely anticipated.

“The odds still heavily favor the ECB keeping interest rates at 1.00% through 2010 and very deep into 2011,”said Howard Archer, chief European and U.K. economist, IHS Global Insight. “There seems good reason to expect underlying inflationary pressures to remain muted in the Eurozone given overall gradual recovery, significant excess capacity and muted wage growth.

Europe’s economic rebound has largely been fed by a recovery in global demand for Eurozone exports, which grew by 4.4% in the second quarter. But the economic outlook for Japan has darkened lately, and even China’s growth appears to be cooling.

U.S. Federal Reserve chairman Ben Bernanke recently conceded that the Fed may have to back another round of monetary easing if the U.S. economy continues to weaken.

Earlier Thursday, Sweden’s central bank has raised its key interest rate by a quarter of a percentage point to 0.75%, citing the pickup in exports and an improved labour market. Sweden is a European Union member but doesn’t use the euro.

The ECB isn’t expected to make substantial changes to the remaining special liquidity arrangements for banks that were introduced at the height of the financial crisis, as it is well aware that the cost of sorting out the government debt crisis in a number of countries in Europe will be heavy.

The rate decision comes on the same day the European Commission’s research body, Eurostat, reported GDP growth for the Eurozone jumped to 1.0% in the second quarter, marking the fourth consecutive quarter of growth.

Year-over-year growth revised upward to 1.9%. It had previously been reported as 1.7%.

Germany led the Eurozone with 2.2% growth for Q2, while France and Italy posted growth rates of 0.6% and 0.4%, respectively.

There was strong growth among some of the smaller economies, as the Netherlands and Austria each reported growth of 0.9%, and Belgium grew by 0.7%.

There were also predictable pockets of weakness. Greece and Portugal continued to struggle, with economic contractions of 1.5% and 0.2%, respectively. Greek GDP has fallen 3.5% year-over-year.

“Despite the much-improved second-quarter improvement and some decent data so far in the third quarter, the Eurozone recovery looks likely to lose some momentum over the coming months in the face of serious headwinds,” Archer said.

He points to increased fiscal tightening across the continent, a high probability of slower global growth and sovereign debt issues as the main threats. Unemployment remains a concern at 10%, and Archer warns that it could still rise, as governments pare back the civil service. Among those who still have their jobs, wage growth remains muted.

His forecast for the full year is for Eurozone GDP to grow by just 1.5%, with 2011 even weaker, with just 1.3% growth.

“Despite the marked pick up in Eurozone GDP growth in the second quarter, the ECB is likely to remain wary about the longer-term strength of the recovery,” Archer says. “Consequently, we expect the ECB to keep interest rates down at 1.00% through the rest of 2010 and much of 2011, helped by ongoing muted underlying inflationary pressures across the Eurozone.

“Indeed, we do not expect the ECB to start raising interest rates until the fourth quarter of 2011 and then only very gradually.”

(09/02/10)

Originally published on Advisor.ca