ECB holds rates, warns market tensions may persist

Economists at Italian bank UniCredit and the United States's Lehman Brothers said Trichet's remarks were making them shift their bets towards a rate cut in the second half of the year.

"While we do expect a drop in the inflation rate from its current high level in April, the inflation profile is no longer compatible with a rate cut as early as in June," said Lehman's Laurent Bilke.

"Another upside surprise has been the continued strength of bank lending to non-financial firms," he added.

Trichet said there were no signs of constraints in loan supply, despite credit market tensions, though lending standards had tightened.

Overall, the ECB's staff have forecast that the euro zone economy will slow to around 1.7 percent this year from 2.6 percent in 2007 -- a more optimistic outlook than that of most banks and the International Monetary Fund, which cut its 2008 forecast to 1.4 percent on Wednesday.

Growth is slowing much more sharply in some parts of the euro zone such as Spain, where the large construction sector has suffered from a housing slowdown, than in others such as Germany where the rising euro has so far left exports relatively unscathed.

But Trichet dismissed concerns that this growth divergence in the 15-nation currency bloc was a problem for the ECB.

"The Governing Council looks at the continent as a whole, from Helsinki to Lisbon, from Nicosia to Dublin, from Malta to Ljubljana," he said.

(Writing by David Milliken and Krista Hughes; Editing by Gerrard Raven)