By Eva Kuehnen and Sakari Suoninen
FRANKFURT (Reuters) - Markets have settled after Italy's fractured election result and any threat of contagion to other euro members has been muted, European Central Bank President Mario Draghi said on Thursday, suggesting the bank is in no mood to act.
The 17-country bloc's central bank discussed cutting interest rates, but decided to keep them on hold, citing positive economic survey indicators, which in turn suggest the ECB is ready to keep rates at 0.75 percent barring the economy taking another turn for the worse.
Italians delivered a strong rejection of austerity measures at elections last week and left no party grouping with enough support to form a durable government, raising the prospect of backsliding on economic reforms and debt-cutting measures.
Draghi, an Italian himself, said there were many signs that market confidence in the euro area was returning.
"Markets after some excitement immediately after the elections have now reverted back, more or less, to what they were before," Draghi told a news conference after the ECB held its benchmark interest rate at a record low.
"You have seen certainly that the contagion to other countries has been muted this time, contrary to what might have happened about a year and a half ago. And this is another positive sign," he said.
The ECB has calmed the euro zone crisis with its pledge to buy government bonds in potentially unlimited amounts but it will only do so if a member country seeks help from the bloc's rescue fund and agrees to austerity policy conditions.
The programme, dubbed Outright Monetary Transactions (OMT), has not yet been deployed and Italy could find itself outside the ECB's umbrella if it cannot form a government prepared to adhere to its rules.
If divided parties cannot reach a deal, the country could face a new election within months, extending the period of uncertainty.
"OMT remains, is in place," Draghi said. "It is a very effective backstop, and it is there. But you know the rules."
A Reuters poll of economists showed uncertainty stemming from Italy's election makes it more likely the ECB will have to help struggling countries by buying their bonds at some point but with Spain, not Italy, the most likely recipient.
Ten-year Spanish government bond yields fell to 4.93 percent on Thursday. Italian yields, which approached 5 percent after the election, were at 4.63 percent.
RATE CUT DISCUSSED
The decision to keep rates on hold was in line with expectations. But a growing minority of respondents in a Reuters poll - 22 out of 76 - expect the ECB will eventually cut its main refinancing to a new record low of 0.5 percent.
"The door to a rate cut was not opened further, neither was it closed," ING economist Carsten Brzeski said. "Rates should remain on hold unless the economic recovery fails to materialise in the coming months."
Draghi said a rate cut had been discussed and signalled that some members of the bank's Governing Council had been in favour of such a move, but gave no strong hint that further easing was on the cards, pushing the euro to a session peak against the dollar.
"We have discussed the possibility of doing it. So there was discussion. The prevailing consensus was to leave the rates unchanged," he said. When decisions have been unanimous, he generally says so.
Draghi also poured cold water on the view that it could take the interest rates on bank deposits at the ECB into negative territory, saying that such a move could have "serious" unintended consequences.
ONLY GRADUAL RECOVERY
The ECB staff lowered its forecast for the currency bloc in 2013. Gross domestic product is expected to fall by between 0.1 and 0.9 percent this year, below a previous range of -0.9 to +0.3 percent.
"Later in 2013, economic activity should gradually recover, supported by a strengthening of global demand and our accommodative monetary policy stance," Draghi said.
He added that downside risks to the economic outlook prevailed, particularly if euro zone governments were slow to implement structural economic reforms.
Inflation ranges were "broadly unchanged" but if growth turned out to be weaker than expected then so would price pressures, Draghi said.
Despite staff projections putting next year's inflation at about 1.3 percent, Draghi brushed off it undershooting the ECB's target of just below 2 percent, saying it was still basically in line with the aim.
The ECB has singled out the uneven transmission of its record-low interest rates across the currency bloc as its main problem, meaning that a rate cut could have only limited impact.
Draghi also dampened speculation that the ECB was planning special measures to help small businesses.
"We are not at this point in time ... committing or planning anything special," Draghi said when asked about possible moves to boost lending to SMEs, including potential changes to collateral rules.
(Additional reporting by Noah Barkin, writing by Mike Peacock. Editing by Jeremy Gaunt)
