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ECB opens door to quantitative easing

Tuesday, March 25 15:33:28

The European Central Bank could buy loans and other assets from banks to help support the euro zone economy, Germany's Bundesbank has said, marking a radical softening of its stance on the contested policy.

The ECB has cut interest rates to a record low and promised to keep them low for some time, having also flooded the banking system with cheap crisis loans. But the euro zone economy is still weak and inflation remains stuck below the ECB's target.

As the search for alternative measures continues, Bundesbank President Jens Weidmann entered the debate, saying the ECB could consider purchasing euro zone government bonds or top-rated private sector assets, opening the door to one of the ECB's most divisive policy options - quantitative easing (QE).

"Of course any private or public assets that we might buy would have to meet certain quality standards," Weidmann, who is a member of the European Central Bank's Governing Council, told MNI in an interview published on Tuesday.

"But the overall question is one of effectiveness, costs and side-effects. We are currently discussing the effectiveness of these measures. The intended effects would then have to be weighed against the costs and side-effects," he said.

There was currently no need to act, Weidmann stressed, but if the outlook for inflation changed, for example as a result of a stronger euro exchange rate, the ECB could step in to preserve price stability, most likely with another interest rate cut and as a so far more theoretical option, QE.

Weidmann's ECB Governing Council colleague, Jozef Makuch who heads Slovakia's central bank, said deflation risks in the euro zone had risen and a number of ECB policymakers were prepared to take decisive steps if needed, also not ruling out QE.

"If circumstances show that it is needed to support adding liquidity, I do not have a reason not to support it, but I do not have a reason to pre-judge, because I do not know those circumstances," he told a news conference.

The euro fell broadly after Weidmann's comments to around $1.3790. The European Commission' vice-president for industry, Antonio Tajani, had said earlier on Tuesday that at $1.40 the euro was too strong.

Makuch said it should weaken by the end of the year, however.

The ECB has started to pay closer attention to the euro exchange rate and its impact on the outlook for inflation, and Weidmann said a negative deposit rate could be a way to address the impact from a strengthening currency.

"If you wanted to counter the consequences of a strong appreciation of the euro for the inflation outlook, negative rates would, however, appear to be a more appropriate measure than others," he said. "But we are talking about hypothetical scenarios here and not about imminent decisions."

A negative deposit rate would mean that banks have to pay to park their funds at the ECB overnight. The impact such a step would have to improve bank lending to companies and households is "debatable", Weidmann said.

The Bundesbank represents the 18-member euro zone's biggest economy, Germany, and its president's words carry weight in the debate over what the ECB should do as traditional tools such as changing borrowing costs lose their force.

Weidmann cited limits under the ECB's mandate on funding governments, which a pending German constitutional court ruling on the legality of the Outright Monetary Transactions(OMT) bond purchase programme is expected to underline.

"This does not mean that a QE programme is generally out of the question. But we have to ensure that the prohibition of monetary financing is respected," Weidmann said.

"We need to discuss this and ideally achieve a common view."

QE would represent a radical departure for the ECB, which has so far refrained from taking such a step also because it is such a highly political issue in the euro zone.

Weidmann's predecessor Axel Weber resigned in 2011 in protest at the ECB's first government bond purchase programme at the height of the euro zone debt crisis and Weidmann was the only Governing Council member to vote against the OMT in 2012.

The Bundesbank is concerned about overstretching the ECB's mandate of preserving price stability and venturing too far into the realm of financing governments by buying sovereign debt, something that it is banned from doing under EU law. (Reuters)