ECB would need to go beyond ABS market for potential QE -Draghi

WASHINGTON, April 12 Sat Apr 12, 2014 4:23pm EDT

WASHINGTON, April 12 (Reuters) - The European Central Bank could not rely solely on purchases of asset-backed securities (ABS) if it resorts to unconventional steps to boost inflation, given the limited supply of the securities, ECB President Mario Draghi said on Saturday.

If the ECB starts injecting money into the economy using asset purchases, it is expected to choose a mix of government and private assets, including ABS, which collapsed during the financial crisis and are still recovering.

"The present size of the ABS market is about 100 billion (euros) so it is relatively small," Draghi told a news conference in response to a question on how useful the ABS market could be in the ECB's unconventional policy measures.

"We may even consider other unconventional measures."

Speaking on the sidelines of the IMF-World Bank spring meetings in Washington, where the issue of weak euro zone inflation took center stage, Draghi said bond purchases had to be guided by European Union law and take into account European companies' preference for financing themselves through bank loans rather than issuing bonds.

"We have to have these two dimensions in mind when we design a programme," he said.

The ECB has twice embarked on bond purchases, first buying up covered bonds used to back mortgages and then purchasing limited sovereign bonds to keep markets turning over during the worst of the financial crisis.

But it has never ventured into pumping money into the financial system via bond purchases, something which is now on the table as inflation veers dangerously low.

Other ECB officials attending the Washington meetings, including Vice President Vitor Constancio, also said that the ECB would look at all instrument classes, not only private assets.

A Eurosystem official, speaking on condition of anonymity, said this referred to purchases of government bonds on the market because sovereign bonds were the only market deep and liquid enough to make the required impact.

But it was not obvious which bonds to buy, the official said, because while buying Greek or Portuguese paper could help tame deflation there, the falling consumer prices in these countries were part of a natural adjustment of their economies to become more competitive, and were actually welcome.

Buying German bonds, on the other hand, could boost overall euro zone inflation more quickly, because Germany, the euro zone's biggest economy, had the greatest impact on the overall consumer price index, the official said.

Draghi said it was premature to discuss if the bank would first decide to use its remaining room for rate cuts or move directly to unconventional measures if inflation data again turned out to be lower than expected.

DEFLATION WORRIES

The ECB wants to keep inflation below but close to 2 percent over the medium term, but consumer price growth slowed to 0.5 percent year-on-year in March after staying in what Draghi called a "danger zone" of below 1 percent since October.

Low inflation is a problem not only because there is a risk it could turn into a stubborn cycle of falling prices, or deflation, but also because it makes it harder for euro zone countries to reduce huge public debt and become more competitive in the global economy.

"We have made an assessment in March and the profile, the inflation path that was projected didn't grant decision-making by the (ECB) Governing Council at that time," Draghi said.

"What drives the Governing Council to decide are two things: one is an unwanted tightening of monetary financial conditions and the second is deterioration of our medium-term outlook."

Unwanted tightening of monetary conditions meant, for example, a further strengthening of the euro exchange rate.

"In a sense, if you want our monetary policy to remain as accommodative as it is today, a further strengthening of the exchange rate - I don't want to give you a level where we will act or not, I am giving you an orientation - would require further monetary policy stimulus," he said.

A deterioration of the medium-term outlook could happen if inflation data for April or May were to be weak again, diverging from the bank's main scenario that price growth will gradually pick up towards 2 percent over the next two years.

Constancio has said that the April inflation data would be key to a decision whether to start unconventional easing, while Governing Council member Ewald Nowotny said he expected the ECB to wait until its June meeting with a decision because the bank would then also have new economic growth forecasts. (Reporting by Jan Strupczewski; Editing by Paul Simao)

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