ECB holds interest rates at record 0.5 per cent as economy lags

The European Central Bank (ECB) has left its benchmark interest rate unchanged at a record low of 0.5 per cent as it searches for new ways to lift the euro area's economy out of recession.

The decision came at a meeting of the bank's 23-member governing council at its headquarters in Frankfurt, Germany.

In May, the ECB cut its main rate by a quarter-point in an attempt to kick-start the economy of the 17 European Union countries that use the euro. Analysts predicted it would pause this month to assess the region's economy.

The Eurozone's annual gross domestic product shrank 0.2 per cent in the first quarter, the sixth quarter in a row. The central bank for the currency shared by 331 million people has predicted that the economy will start growing again gradually in the second half of this year.

But conflicting economic indicators have left doubt about whether a recovery will come through by then or not. The unemployment rate of 12.2 per cent is the highest since the currency union was formed in 1999, adding pressure to find some kind of stimulus.

ECB President Mario Draghi has said the bank is talking to other European Union institutions about ways to encourage banks to lend more to small companies - the backbone of the Eurozone's economy. But it is not clear when a proposal might be ready.

Markets are waiting to hear Draghi's comments about the bank's plans at a news conference after the rate decision. Analysts say the bank could also lower its growth forecast for this year - it recently predicted a contraction of 0.5 per cent for the year.

The ECB's governing council meets once a month to decide on the bank's refinancing rate. That is the rate at which it loans money to private-sector banks. Through them, the refinancing rate influences how much it costs businesses and consumers to borrow.

Lower rates in theory make it easier to for companies to invest in new production or for people to buy things, and that should stimulate the economy. But that's not how it has been working out in Europe. Lending to businesses remains weak.

The low ECB benchmark rate is not being passed on by the banks in the countries hardest hit by the Eurozone's debt crisis, such as Spain and Italy. Banks remain risk-averse in the aftermath of the financial crisis and new rules limit how much they can lend relative to how much capital they have. Some banks are having trouble borrowing themselves. So credit is hard to come by and the worst-hit are small businesses.

The ECB has talked about encouraging banks to bundle small business loans and have them sold off in the form of bonds. The process would reap more money, which could then be loaned out. The practice already exists, but loan guarantees from another European government institution such as the European Investment Bank could encourage more of it.

However, it could be sometime next year before something like that can be set up, and ECB officials have recently downplayed how big an impact it would have.