The European Central Bank and the Bank of England left their key interest rates on hold at 4.25% and 5%, respectively.

TD economists are now looking towards possible rate cuts from both central banks in 2009.

The ECB raised interest rates in July, but left them unchanged today as expected. TD reported that with oil prices down 20% since the ECB’s July meeting, and GDP and other economic indicators coming in weaker than expected, ECB president Jean-Claude Trichet emphasized that all of the developments “confirmed their decision” to raise interest rates last month.

“It will take more than just one month of falling oil prices to convince the [ECB] that a new trend has materialized and that the risks of second round effects are fading,” it says.

“While today’s statements should be classified as hawkish, there were several elements to suggest that the ECB would be comfortable considering a policy easing at a later date,” TD notes. “Trichet noted that the weakening growth was only ‘in part’ expected, and that the downside risks identified in prior statements were materializing… Moreover, Trichet added that the adjustment costs associated with high energy and food prices lowers the capacity constraints of the economy to some extent. This means a slower pace of economic growth than in the past can drive inflation higher.”

Trichet also said he saw “a little bit less net tightening” and still “no signs of significant constraints on bank loan supply,” TD adds.

“We feel it will be more important to watch lending growth rather than GDP growth to sense a shift in ECB policy,” it says. “The 3-month annualized trend in lending to the private sector has just moved into territory consistent with ECB cuts and would need to show further softening to spur lower interest rates. We believe headline Eurozone inflation has peaked in July, and that the risks are balanced that it will near 2.5% by December and that the ECB will cut interest rates in March and May of 2009.”

Meanwhile, the Bank of England also left interest rates unchanged today. It doesn’t issue a statement when rates are not moved. Nevertheless, TD says, “What is clear is that the UK economy is quickly decelerating and has a real risk of slipping into a recession over the next few quarters.”

“If oil prices continue to moderate as we expect, we think the merits for a near-term rate cut are much stronger in the UK than in the Eurozone,” TD says. It is currently calling for four cuts from the BoE in October, January, March, and May, but TD allows, “there is a strong risk that the October cut may be too bold given the current economic uncertainty.”