UPDATE 1-Coeure: ECB will not bow to market pressure - paper

Fri Oct 12, 2012 3:07am EDT

Related Topics

* Says risk of deflation greater than inflation

* But ECB's priority is price stability over growth

* Says ECB will only buy bonds if its conditions met

FRANKFURT, Oct 12 (Reuters) - The European Central Bank will not cave in to market pressure and buy bonds of euro zone governments whose borrowing costs have reached unsustainable levels if the country does not comply to the ECB's rules, Executive Board member Benoit Coeure said.

In an interview with German daily Die Welt, Coeure also said the 17-country euro zone was flirting with recession.

"The economies of several euro zone countries are contracting at the moment, and the euro zone as a whole is currently not far from a recession," he said. "Consequently, the risk of deflation is greater than the risk of inflation."

"But if the central bank Council must choose between more inflation or less growth, then price stability would always have priority."

The ECB impressed markets last month by launching a new and potentially unlimited bond purchase programme under which it will buy governments' short-term bonds once they have signed up to a European bailout programme.

Coeure doused hopes that the ECB would intervene regardless of whether its conditions were met once a country's borrowing costs soared.

"We will not cave in, but only intervene once our conditions have been met. We will prove it to you," Coeure said, adding that the bank would only buy bonds if the International Monetary Fund was involved, even if only to monitor the programme.

The ECB tied its bond-market intervention to reform commitments to make its new programme more effective and to soothe concerns raised by Germany's Bundesbank that the ECB was taking on too much risk and getting too close to the taboo of financing governments.

Coeure said Bundesbank President Jens Weidmann was right to raise such concerns, but added that doing nothing was not an option.

"The environment has changed a lot over the past years. The challenge for the ECB is to adapt its monetary policy to the new circumstances and to still stay within tradition of the Bundesbank," Coeure said.

BANKING WATCHDOG

IMF Managing Director Christine Lagarde on Thursday said that struggling European countries such as Greece should be given more time to reduce their budget gaps.

Coeure, however, stressed that the ECB would not help Greece beyond providing solvent banks with liquidity in return for sufficient collateral.

"It has to be clear that the central bank will not finance governments via the printing press, neither direct nor indirect. This means: If further emergency loans to banks are purely for buying government bonds, then the ECB Council should not approve it," Coeure said.

Coeure also said the plan for a new European banking supervision under the roof of the ECB could be implemented step by step as long as the legal framework was in place from the beginning of next year.

ECB President Mario Draghi and Germany's markets regulator cautioned earlier this week that setting up a new system of supervision would take up to the end of next year, later than many expected and a potential setback to efforts to help distressed euro zone countries and their banks.

"We should be pragmatic about it. The highest priority is that the supervision works. If more time is needed, then we should take that time," Coeure said.

While it was "very important" for the ECB's preparations that the new supervisory structure was legally in place as planned from January 2013, the actual supervisory work could be moved across to the ECB step by step later, Coeure added.

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