UPDATE 2-Fed's Dudley urges Europe banking union, warns on economy

Mon Apr 22, 2013 9:58am EDT

By Jonathan Spicer

NEW YORK, April 22 (Reuters) - Establishing a pan-European banking union is a "critically important next step" to stabilizing that region's troubled economy, an influential U.S. Federal Reserve official said on Monday, wading into a debate that has split the euro zone.

William Dudley told a conference on transatlantic economic interdependence that Europe's economic outlook "seems less bright" and support for fiscal and structural changes could further erode if growth does not "resume relatively soon."

Protracted recession and a series of banking crises in Europe have hampered the global economy and the frustratingly slow U.S. economic recovery. Still, higher taxes and lower government spending at home remain the Fed's main concern for the United States.

Dudley, head of the Federal Reserve Bank of New York, again urged U.S. politicians to loosen fiscal policies.

He also repeated support for the U.S. central bank's stimulative asset-purchase program, saying the efficacy of quantitative easing has been "as high or higher than" he originally expected and the costs have been "the same or lower."

Turning to the euro zone, Dudley urged Europeans - and "not just in the periphery" - to take advantage of their opportunity to reform labor and product markets to boost growth prospects.

Banking union aims to stabilize the euro zone by separating ailing banks from state finances. It would clarify how to deal with troubled banks, such as those in Cyprus that recently needed bailouts.

But Germany and others have called for a change in the European Union treaty to allow for the union, raising questions about how fast it can be implemented.

"Banking union has the potential to make a powerful contribution to euro zone stability and growth, both in the short term and in the long term," said Dudley, a permanent voter on policy at the U.S. central bank and a close ally of Fed Chairman Ben Bernanke.

He argued a union would help fix the "impaired" monetary policy transmission channels, especially to peripheral countries; strengthen market confidence in the overall banking system; and would highlight that "a euro is a euro and will remain a euro throughout Europe."

Dudley added: "The bad news is that the euro zone is still in recession and the political support for further rounds of budget-tightening has clearly lessened."

The European Central Bank is to start supervising euro zone banks next year as a first step toward union. A resolution plan to close or salvage struggling banks should come next, followed by a coherent framework across Europe for deposit protection.

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