ECB slashes forecasts for euro zone, outlines bond buy

FRANKFURT (Reuters) - The European Central Bank said on Thursday it expected the euro zone recession to last for another year, unveiling details to pump cash into the troubled economy, and kept interest rates at a record low 1.0 percent.

It slashed its forecasts for the 16-country economy this year, but provided a glimmer of hope by only trimming key 2010 numbers.

ECB staff predicted the euro zone economy would now shrink by up to 5.1 percent this year, compared with their previous worst case scenario of a 3.2 percent decline. They signaled it would also struggle to grow in 2010 -- forecasting a change in GDP of between -1 percent and +0.4 percent.

President Jean-Claude Trichet also maintained market expectations that the ECB is unlikely to cut interest rates below the current record low 1.0 percent soon. He said "current interest rates were appropriate," adding his now customary caveat that the bank had not ruled out another reduction.

The staff forecasts also showed inflation was expected to remain well below the ECB's target of below, but close to 2 percent for this year and next. Forecasts for inflation in 2010 were unchanged at between 0.6 and 1.4 percent.

They see economic activity declining less sharply in the second half of 2009 than in the first, but this would still dampen price pressures. "After a stabilization phase, positive quarterly rates are expected by mid 2010," Trichet said.

BONDS

Earlier the ECB announced that its key interest rate was unchanged, and markets' attention focused on the details of its plans to buy 60 billion euros in covered bonds and clues on whether rates would be cut further.

The bond purchase program aims to help the euro zone economy out of recession by lowering long-term borrowing costs.

Trichet said the bank would spread the purchases across the euro zone, buying bonds rated between AA and BBB-, in both primary and secondary markets.

Asked whether the purchases would be sterilized, he said there were no other decisions made at Thursday's meeting but added: "We are not embarking on quantitative easing."

Although he said he did not want to pre-judge future ECB decisions, Trichet left little room for any imminent increase in the size of the program, saying the decision was for 60 billion euros ($85 billion) "full stop."

Euro zone and British government bond futures hit a session low while euro interest rate futures extended falls after Trichet's initial statements.

Trichet also gave a glimpse into relations between the ECB and the euro zone's biggest member, Germany.

He said he had responded to recent criticism from German Chancellor Angela Merkel about the ECB's actions to pump money into the economy in a phone conversation with her.

"I told ... (Merkel) that we are fiercely independent," he said. "I can tell you she confirmed to me she was fully respecting the independence of the ECB, fully backing what we were doing in full independence."

ON HOLD

All but 2 of the 78 analysts polled by Reuters forecast the ECB's decision to hold rates at its monthly policy meeting.

(For poll, double click , for graph, click http://graphics.thomsonreuters.com/RNGS/JUN/RATE.jpg)

Most analysts believe ECB rates have reached their lowest point and will stay there until at least the end of next year. While some ECB policymakers have said they are unwilling to go below 1 percent, Trichet repeated his comment from last month that this level was not necessarily the lowest limit.

One in four economists polled saw further easing by September.

The Bank of England also decided to keep UK rates on hold on Thursday at 0.5 percent and the Bank of Canada left rates unchanged as well at 0.25 percent.

The euro zone's economy shrank 4.8 percent in the first quarter of the year from the same period a year earlier and the ECB had been more cautious than some of its peers about whether there are signs the economy might be about to recover.

($1=.7050 Euro)

(Reporting by Sakari Suoninen; writing by Marc Jones and Krista Hughes; editing by David Stamp)