ECB's Weber-Liquidity exit to end with full allotment

FRANKFURT Dec 9 (Reuters) - The European Central Bank will probably keep lending banks unlimited funds at weekly operations until all other special liquidity measures have been withdrawn, ECB Governing Council member Axel Weber said late on Tuesday.

Weber told the International Club of Frankfurt Business Journalists that the ECB's ultimate goal was to return to its pre-crisis schedule of liquidity operations and widen the gap between its main policy rates, but this would happen gradually.

The German Bundesbank head predicted more of the ECB's extraordinary liquidity measures would be withdrawn next year in reverse order of their introduction, ending with full allotment at weekly lending operations.

"Our goal is to return in an orderly, staggered way to our normal policy framework," he said in comments approved for release on Wednesday. "The withdrawal will be inversely proportional to the introduction."

Although the ECB had decided to end its 12 and six-month loans, it was keeping its extra one-month operations and full allotment over shorter loan horizons at least through the first quarter of next year.

"I think at the end we will return the main refinancing operations, as the final operation, from full allotment to the normal tender process," Weber said.

"And I think something else which was a response to the crisis, reducing the gap between the rates on the overnight lending facility, the main refi rate and the deposit facility to 75 basis points, also this will probably return to normality when the first rate rise comes. Then we are back to normal monetary policy territory."

The ECB currently sets the rates at its overnight deposit and overnight loan facilities 75 basis points each side of its main policy rate -- now 1 percent -- but until October 2008, this gap was 100 basis points.

Weber said it was a combination of low policy rates and full allotment which had driven overnight market interest rates EONIA= down to well below the ECB's main policy rate, and that would not change in a hurry.

"I expect that Eonia in the first quarter will be notably under the main refi rate," he said.

"As the measures are withdrawn ... Eonia will increasingly move away from lower end of the (interest rate corridor). But I don't think that will be a quick process."

NO DECISION ON RATES

Weber stressed the ECB had made no decision on a full exit from support measures, and did not want to send any signals about the future path of interest rates.

"We have made no decision, and want to send no signal, about when in addition to the withdrawal of extraordinary measures, rate rises will have a role to play," he said.

The exit was not driven by time concerns, but conditions in markets and the economy, and in the first quarter the ECB would be in a better position to judge these.

"Rate rises will be solely and only decided on a combination of economic and inflation risks, as always," he said.

Weber said the ECB's decision last Thursday to start phasing out its extra liquidity measures was not a tightening in policy. Given the improvement in markets and the economy, leaving policy settings as they were would have meant a further loosening in the ECB's stance. "We decided not to increase the degree of expansion further," he said. "It's not a more restrictive monetary policy."

Weber said the ECB's last assessment was that the inflation outlook was "relatively relaxed" but the central bank would act decisively if risks emerged sooner than expected.

Overall, the medium-term outlook for euro-zone inflation of around 1.5 percent was not incompatible with the ECB's price stability goal, which aims to keep inflation below but close to 2 percent, he said.

Euro zone central bank staff last week forecast 2011 inflation in a range of 0.8 to 2.0 percent.

Although the economy was on the road to recovery, the path would be uneven, Weber said, warning against "euphoria".

He also said he saw no credit crunch, and thought it was feasible that Germany would get its budget deficit down under 3 percent of gross domestic product in 2012. (Reporting by Krista Hughes and Andreas Framke; Editing by Toby Chopra)