June 22 (Bloomberg) -- European Central Bank Governing Council member Ewald Nowotny said the bank is likely to keep interest rates steady for at least the rest of the year.

The ECB won’t substantially alter its assessment of the economic outlook and “therefore I also don’t see a likelihood for rate changes,” Nowotny, who heads Austria’s central bank, said in an interview in Vienna on June 19. “If the economy is developing in the way that we expect, I do not see a perspective for this year and we will need to look again next year.”

The ECB kept its benchmark rate at a record low of 1 percent this month and said it expects the euro-region economy to contract about 4.6 percent this year before returning to growth by the middle of 2010. The Frankfurt-based bank will step up its response to the crisis tomorrow when it launches its first auction of 12-month money for banks at the benchmark rate.

While the ECB has left the door open for another rate cut if needed, Nowotny said commercial banks are expected to show “substantial interest” in the 12-month loans and suggested that’s partly because they understand the cost of borrowing is unlikely to drop further.

At the same time, he indicated the ECB has room to hold rates at their historic low to help the economy out of its slump and prevent an extended period of stagnation.

“Banks know the ECB is following a policy of the steady hand so they don’t expect fast changes in the interest rate,” Nowotny said. “And I think banks more or less also share our expectations regarding the economic outlook.”

‘Quite Dovish’

“The comments are quite dovish,” said Jacques Cailloux, chief euro-area economist at Royal Bank of Scotland Plc in London. “If the economy is as bad as the ECB anticipates, there is no way they should raise rates at all in 2010.”

The euro rose to $1.3875 after Nowotny’s comments were published from $1.3863. The yield on the 10-year German government bond fell.

“We are in uncharted waters, and there are still risks of a sudden emergence of unexpected financial turbulence,” ECB President Jean-Claude Trichet said in a speech in Madrid today. “While there are first signs that the pace of economic weakening is decelerating, we must remain alert.”

Business confidence in Germany, the region’s biggest economy, rose for a third month in June, the Ifo institute said today. Still, unemployment is projected to climb further as Europe’s worst recession since World War II prompts companies to retrench.

Free to Fight

“I do see positive signs but I also see, with regards to the economy, with regards to unemployment, some challenges,” Nowotny said. “To a certain extent the worst may be behind us, but there is still the need to be cautious with regard to future developments. As we do not see inflation risks, the ECB is also free to contribute to fighting the deep recession. It is necessary to use all possible means to secure a recovery.”

The ECB will start buying 60 billion euros ($84 billion) of covered bonds next month to encourage the flow of credit. Nowotny said policy makers agreed on technical details for the program last week. The purchases will be carried out mainly by the 16 national central banks in the euro region and the maturities of the bonds won’t exceed five years, he said.

Germany’s Axel Weber has said the ECB should raise interest rates and withdraw extra liquidity quickly once the economy starts to gather strength in order to prevent a build-up of inflationary pressures.

No Abrupt Changes

Nowotny said while it is “quite obvious” that the ECB has to unwind its expansionary monetary policy at some point, “the exit strategy has to be seen in a macroeconomic context.” He said the ECB expects the economy to start growing again at a “low” rate in the second quarter of 2010.

Economists don’t expect the ECB to start raising rates before the fourth quarter of 2010, a Bloomberg survey shows.

“I cannot tell you what would be the interest rate in the fourth quarter of next year and nobody can seriously say that,” Nowotny said. “If the outlook changes, then of course policy responses would be needed. For the time being I can say that the policy of the ECB has been adequate for the economic situation as we have it, and I personally am a strong supporter of a steady-hand policy approach. The ECB should not and will not make any abrupt changes.”

To contact the reporters on this story: Jana Randow in Frankfurt at jrandow@bloomberg.net; Zoe Schneeweiss in Vienna at zschneeweiss@bloomberg.net.

Last Updated: June 22, 2009 08:35 EDT