August 19, 2011 / 11:22 AM / 9 years ago

Risky to keep rates too low for long - ECB's StarK

FRANKFURT (Reuters) - European Central Bank heavyweight Juergen Stark said leaving interest rates too low for too long was risky, highlighting reservations at the ECB about reversing policy course despite markets’ recession fears.

A sculpture showing the Euro currency sign is seen in front of the European Central Bank (ECB) headquarters in Frankfurt April 7, 2011. REUTERS/Alex Domanski

The ECB has raised rates twice this year but market worries that major economies are heading for recession and a vow by the U.S. Federal Reserve to keep its rates near zero for two years have put pressure on the ECB to abandon its tightening cycle.

Stark resisted this pressure, telling Germany’s Handelsblatt business daily in an interview published on Friday: “Keeping interest rates too low for too long carries risks.”

The ECB raised its main interest rate in April and July — by 25 basis points each time — and it now stands at 1.5 percent.

Asked whether central banks were accelerating the crisis by employing loose monetary policy, Stark noted that the ECB had never cut its main refinancing rate to an extremely low level.

Germans’ fear of inflation, which at 2.5 percent in the euro zone is above the ECB’s target of just below 2 percent, heavily influences the mindset of the ECB’s Governing Council.

Stark and fellow German Jens Weidmann, president of the Bundesbank, are powerful figures on the 23-member Council, which will be reluctant to reverse its policy tightening course even though European shares hit new 2-year lows on Friday.

“They want to be absolutely sure this turmoil is affecting the real economy,” said Jens Sondergaard, economist at Nomura.

Another ECB Governing Council member, Yves Mersch, said last week it would be a close call next month as to whether the Frankfurt-based central bank tones down its view of the risks to inflation.

Euribor futures show markets have priced out further rate hikes for the next couple of years, and also see around a 30 percent chance that the bank may be forced to cut rates again.

CRISIS MODE

The ECB has been forced back into crisis mode as the euro zone’s debt troubles spread to Italy and Spain.

It started buying the bonds of both countries earlier this month for the first time in its history and injected six-month funding into troubled money markets for the first time in over a year.

The pace at which the ECB would continue its bond-buying programme would depend on tensions on markets, Stark said.

“The speed and volume will depend on the ECB Governing Council’s assessment of the market situation ... What is decisive is how long tensions in the markets persist,” he said.

Stark, who holds the economics portfolio on the ECB’s six-member Executive Board, was one of four members of the ECB Governing Council who earlier this month opposed the reactivation of the bank’s bond-buying plan.

The six Executive Board members sit on the ECB’s 23-member Governing Council, which also compromises the euro zone’s 17 national central bank governors.

Stark noted that the ECB’s move on August 4 to offer a round of six-month financing to banks “fulfilled all the liquidity requirements of the banks.”

“We have given here enough liquidity to the banks with a total of 50 billion euros. From the present standpoint, this is a one-time measure,” he said.

On the euro zone sovereign debt crisis, Stark said the idea of common euro zone bonds was a “false solution, which ... provides completely wrong incentives”.

Editing by Toby Chopra

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