UPDATE 2-ECB hawks play down deflation risk and need for policy action

Thu Mar 13, 2014 9:51am EDT

Related Topics

* Weidmann sees no need for fresh policy action

* But if action needed, ECB running out of conventional tools

* Sees legal issues around some unconventional tools

* Knot says unlikely to need further unconventional policy

* Would back negative deposit rate if needed

* But does not see deflation risk getting out of hand

By Paul Carrel and Eva Taylor

FRANKFURT, March 13 (Reuters) - The European Central Bank is running out of conventional policy tools and any new action would quickly take it into territory where legal questions about some options would arise, Bundesbank chief Jens Weidmann said.

A day after a batch of ECB policymakers underlined their readiness to take policy action if needed, Weidmann and Dutch central bank chief Klaas Knot on Thursday highlighted the barriers to the ECB adopting unconventional policy measures.

Stressing that he saw no need for further policy action at the moment, Weidmann said the ECB nonetheless had policy instruments available if necessary.

"But then one comes very quickly to the end of the spectrum of conventional measures," he told a news conference after presenting the Bundesbank's 2013 annual results.

"Unconventional measures, some of which would take us into new territory, would have to be discussed, and in my view there are some very important legal issues there," Weidmann said.

In Amsterdam, Knot said the euro zone is unlikely to need further unconventional monetary policy measures as stability is returning. "At this moment there is no reason for further unconventional measures because we see the deflation risk as very limited," he added.

Weidmann concurred: "I regard the risk of deflation as very small," he told Reuters Insider television.

The comments from Weidmann and Knot, widely regarded as two of the more hawkish members of the ECB's policymaking Governing Council, suggest the barrier for them is high to the ECB embarking on measures such as U.S.-style quantitative easing.

NEGATIVE RATE

Knot said he would be in favour of dropping the deposit rate - the rate the ECB pays banks for holding their money - to below zero if needed, but said deflation fears were not material. "I don't think it (deflation) will get out of hand," he said.

"If that changed we would need to look again at whether we should do anything on monetary stance, the interest rate, or something about the monetary transmission process," Knot added. "We have deployed instruments in both directions before."

The euro zone's central bank disappointed markets last week by leaving interest rates at a record low 0.25 percent and taking no other policy steps, despite forecasting low inflation in the 18-country currency bloc for years to come.

The lack of action was significant - last month, ECB President Mario Draghi had signalled that by the March meeting the bank would have enough information to judge the need for fresh stimulus.

The euro has risen following last week's meeting, hitting a 2 1/2 year high on Thursday and heading towards $1.40. On Wednesday, Spanish central bank chief Luis Maria Linde said further appreciation of the euro could prompt policy action.

Weidmann said the strengthening of the euro could alter the outlook for inflation, which the ECB would have to take into account in its monetary policy stance.

But he said there was no sign of euro zone consumers deferring purchases in anticipation of lower prices ahead. The ECB has identified such a scenario as a sign of deflation taking hold.

Weidmann also said interest rates could not remain low forever: "Low interest rates cannot become a permanent state."

FILED UNDER: