ECB leaves rates on hold, but keeps door open to further rate hikes

LONDON, July 23 (Reuters) - The European Central Bank kept borrowing costs on hold on Thursday but left room for more tightening in the coming months as a widening conflict in the Middle East pushed up energy prices again.

The ECB kept its deposit rate at 2.25% but said it was "closely monitoring the intensity and duration of the shock, as well as its indirect and second-round effects."

The euro extended its falls and was last down 0.28% at $1.1378.

Interest-rate sensitive two-year bond yields across the euro area held higher on the day, with German two-year bond yields last up around 3 basis points at 2.87%.

Money markets price in a high chance of two more rate increases by year-end.

COMMENTS:

SUSANNAH STREETER, CHIEF INVESTMENT STRATEGIST, WEALTH CLUB, LONDON:

"The ECB is in wait and see mode. Policymakers have left rates unchanged because they just really need to gather more data about the outlook.

"And energy prices are very volatile. They still threaten to reignite inflationary pressures just as their confidence had been rising that price growth was heading back towards target. But the problem is it is too early to judge the extent of the second-round effects.

"Where they are now, interest rates still remain restrictive, potentially to lean against inflation. But because the outlook in terms of geopolitics is so cloudy, they (ECB policymakers) really want to only be driven by the data and not make a knee-jerk reaction."

ARNE PETIMEZAS, DIRECTOR RESEARCH, AFS GROUP, AMSTERDAM:

"The ECB held rates as expected. No surprise there. What stands out is that the Governing Council removed the reference that it will 'monitor' the war. It's refreshing to see that they kind of have given up to try to guess where this thing is going. I see the language tweak as a sign that they will hike in September even if the U.S. and Iran somehow manage to return to the Memorandum of Understanding."

MICHAEL FIELD, CHIEF EQUITY STRATEGIST AT MORNINGSTAR, AMSTERDAM:

"The ECB finds itself in something of a tight spot at the minute, with so many moving parts, all signalling different things. Inflation is moving downward and economic growth is weak, which would usually call for rate reductions. But the lingering fear is that the ongoing conflict will reignite inflation."

"Considering all this, the ECB is going with the wait and see approach, preparing to take further action down the line if necessary. For investors this course of action is being viewed as prudent, with equity markets generally holding up in the face of increased uncertainty."

SANDRA HORSFIELD, ECONOMIST, INVESTEC, LONDON:

"It’s not much of a surprise as we can see in the fact that markets have not moved materially, and what we’ve seen has been is more driven by Iran headlines than the ECB."

"Looking at their statement, two words dominate uncertainty and the energy shock. The situation is highly volatile, and from what we can gather from the various ECB speeches between June’s meeting and now, we’ve had some swings already as a result of the situation with energy."

"Now we are back to the ECB’s baseline scenario as the most plausible. While many things can change for the better or for the worse, we’re still probably looking at a hike in September.”

MARK WALL, CHIEF EUROPEAN ECONOMIST AT DEUTSCHE BANK, LONDON:

"Uncertainty is high but make no mistake, the ECB pause in July does not reflect doubt. This is a pause while the ECB updates its forecasts and scenarios, and hikes again in September. The only question is: will one more hike to 2.50% be enough to curb the inflation risks? The answer will depend on growth as much as it will on inflation."

RICHARD CARTER, HEAD OF FIXED INTEREST RESEARCH, QUILTER CHEVIOT, LONDON:

"This will come as no surprise as any subsequent rate rises are likely to be gradual in nature. The ECB is at a much more comfortable starting point than the Federal Reserve and the Bank of England, and as such can be a little more cautious in acting depending on the data."

"Indeed, despite its ability to hold rates today, the market still expects the ECB to be in a rate raising mood for the rest of the year. Clearly how aggressive it is in upping interest rates depends broadly on what is happening away from the continent, and that is making the job of the policy committee incredibly challenging."

DANNI HEWSON, HEAD OF FINANCIAL ANALYSIS, AJ BELL, LONDON:

"All central bankers are trying to strike a balance between making a move that will curb inflation if it does flare in the way that they are concerned about but they're also not wanting to do anything that would jeopardise their economies, if the situation in the Middle East can be resolved quickly. If it does not resolve quickly, we will certainly see the ECB hike once this year, potentially two, but its difficult to read the tea leaves at the moment."

MARCHEL ALEXANDROVICH, EUROPEAN ECONOMIST, SALTMARSH ECONOMICS, LONDON:

"After raising interest rates in June, as expected, the ECB is on hold today. The Governing Council's focus remains on inflationary pressures, with the latest events in Middle East set to push up the ECB's expectations of where inflation is heading later this year. And although no pre-commitment to future policy path is provided, the ECB will clearly have a bias toward tighter policy."

MADISON FALLER, GLOBAL INVESTMENT STRATEGIST, JP MORGAN PRIVATE BANK, LONDON:

"Preserving optionality should not be confused with complacency. As one of the first movers earlier this year to hike amid inflation pressures, today's meeting reinforces the same instinct: to stay in front of the risk, not behind it."

"That keeps September as a live meeting, with the bar to hold edging higher. Policymakers would likely need to see energy prices roll over quickly and little sign of spillover into the broader economy, conditions that look increasingly difficult to meet with energy and inflation pressures clearly back in focus."

CONOR PARLE, EURO ZONE ECONOMIST, FIDELITY INTERNATIONAL, LONDON:

"The ECB left interest rates unchanged at their meeting today, but against the backdrop of higher commodity prices and the latest increased tensions in the Middle East, this pause is likely to be temporary."

"Beyond oil prices, gas prices had been increasing even before the recent heightened tensions. Higher demand to refill low supplies ahead of winter, alongside China increasing imports, are likely supporting further price pressures in the gas market."

"Meanwhile, reasonable resilience in the euro area economy means that, once the ECB updates its September forecasts, it will likely be in a comfortable position to increase rates by a further 25 basis points to the upper end of its neutral range, while sending a clear message about its commitment to price stability."

ED HUTCHINGS, HEAD OF DEVELOPED MARKET RATES AT AVIVA INVESTORS, LONDON:

"Overall, the immediate priority for the ECB is clear: addressing the inflationary backdrop, and as such the market is right in thinking more hikes will be coming down the line, but with one hike already being delivered and more than two further hikes priced, have things gone too far? It’s certainly beginning to look that way."

(Reporting by the Reuters Markets Team, compiled by Dhara Ranasinghe, editing by Yoruk Bahceli and Alun John)