WRAPUP-ECB will know by year-end if latest measures have worked: Constancio

Fri Jun 6, 2014 2:00pm EDT

Related Topics

* ECB will know by December if latest measures successful

* Asset purchases to be used if deflation threatens

* Expects big take up for new batch of cheap loans

* Weidmann tries to ease German concerns, against bond buys

* Nowotny says rates now at quasi lower bound

By Marc Jones and Francesco Canepa

LONDON, June 6 (Reuters) - The European Central Bank will probably not know until the end of the year, after banks have had the chance to take up its cheap loans, whether its latest actions have been effective, its vice-president said on Friday.

The ECB cut interest rates to record lows on Thursday, launched measures to pump money into the sluggish euro zone economy, and pledged to do more if needed to fight off the risk of Japan-like deflation.

Speaking in London a day after the moves, the bank's vice president Vitor Constancio said it would now take a step back to give the changes a chance to work, but that a broad asset purchase programme like those attempted in the United States, Britain and Japan remained an option for the 18-nation euro zone if its economy failed to gain traction.

"Only after the second tranche in December of the initial allowance of the new facility will we then gauge the impact," he said on the sidelines of an IIF conference. "Because by then the comprehensive assessment (AQR) will be completed and banks will know what is their situation," he added, referring to the ECB's scrutiny of banks' balance sheets.

The ECB's bold actions aroused dismay in some German media which warned that drastic loosening of policy could fuel U.S.-style asset bubbles and discourage reform in crisis-hit euro states.

Bundesbank chief Jens Weidmann tried to cool the fears, saying there had been tough wrangling within the ECB over the decisions and that it was absurd to discuss further measures already.

"If the inflation rate is too low for too long, a development looms that could damage the economy and harm all of us," Weidmann said. "That's why we acted. We wrangled long and hard about the shape of the measures. It was certainly not an easy decision."

He also emphasised that he remained opposed to purchasing government bonds. "The ECB cannot be allowed to become the 'bad bank' of the euro zone and my position on buying government debt has not changed," he said.

OPEN DOOR

Despite the concern of Weidmann and Germany, the ECB has left the door open for further action should inflation expectations start falling or if the economy suffers a serious setback.

"For the type of contingencies and challenges we face now, what we did, we think, is enough. If some downward shock were to create a much deteriorated situation then we will have to think about all sorts of unconventional policies," Constancio said.

Earlier, he had told a question and answer session: "If we see a sort of vicious circle emerge out of (low) inflation and an unanchoring of expectations and an outward shock that would create a reverse spiral, that would require a broad programme of asset purchases."

With financial market-derived medium-term inflation expectations still near to 2 percent, however, Constancio said any large scale bond buying was still some way away.

Speaking at the question and answer session, the ECB vice president said interest rates would remain at current record low levels for some time as the euro zone needed inflation and growth rates to rise to help reduce a regional debt overhang.

The bank's main rate is now just 0.15 percent, while its deposit rate is minus 0.1 percent, meaning banks pay to keep cash with the ECB overnight.

In Vienna, Ewald Nowotny, governor of Austria's central bank, said the ECB had broken new ground by agreeing to provide long-term liquidity to banks that prove they are using the money for lending, not just squirreling it away.

He said the ECB's latest formulation of forward guidance for interest rates meant rates were on hold and that they "reached quasi the lower border," though Constancio suggested there might be some wiggle room left with the deposit rate.

"(Mario) Draghi made clear that for all practical purposes this is the lower bound, but he also didn't exclude that in some developments of the situation, we will act," Constancio said.

"As he said, we can still act in some of the key rates... For instance we could tweak with the corridor, not necessarily the main refinancing rate." (Additional reporting by Mike Shields in Vienna and Erik Kirschbaum in Berlin; Editing by Catherine Evans/Ruth Pitchford)

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