ECB's Weidmann says asset purchases "sweet poison" for governments

DUBROVNIK, Croatia, June 12 Thu Jun 12, 2014 2:00pm EDT

DUBROVNIK, Croatia, June 12 (Reuters) - Bundesbank President Jens Weidmann emphasised his opposition to government bond purchases by the European Central Bank on Thursday, calling them "sweet poison for governments" that undermine the central bank's ability to do its job.

Arch-hawk Weidmann was the sole ECB policymaker to oppose ECB President Mario Draghi's signature policy - the OMT bond-buy plan he launched in 2012 to back up his pledge to do "whatever it takes" to save the euro.

Euro zone countries' borrowing costs have fallen significantly since. But Weidmann cautioned in a speech in Dubrovnik that low interest rates ran the risk of creating incentives to postpone necessary reforms in the euro zone.

"Even though financial markets might suggest otherwise, the crisis is far from over," Weidmann said in the text of a dinner speech to be given at the 20th Dubrovnik Economic Conference.

The ECB unanimously decided last week to cut interest rates to record lows - the rate on overnight deposits even below zero - and to launch measures to stimulate lending to small and medium-sized companies, the backbone of the euro zone economy.

Speaking after the June decisions, ECB President Mario Draghi said the central bank was not done yet and could act again if needed, whetting markets' appetite for more action. But the only real option left is a major asset-buying plan.

"Asset purchases may act like a sweet poison for the governments," Weidmann said, speaking about his opposition to the ECB's OMT bond purchase programme. "The rude awakening may come when the purchases are reduced or stopped altogether."

"While sovereign bond purchases are a widely used monetary policy tool, they are not without risks," he said. "They bring monetary policy very close to monetary financing of governments, which could undermine the central bank's ability to maintain its mandate of price stability."

Monetary policy could face the danger of being driven by fiscal policy and finding it very difficult to free itself, he said, the more so as governments became increasingly addicted to asset purchases that kept the interest rates low.

HALF TIME

Government bond yields of euro zone periphery countries, such as Portugal, Spain or Italy, have fallen to record lows recently, but Weidmann warned that market valuations may be running ahead of the adjustment processes, noting signs of growing reform fatigue and rising reluctance to implement further austerity measures.

Speaking in Croatia ahead of the country's opening match of the soccer World Cup against hosts Brazil, Weidmann said: "In footballing terms, I would say 'the half-time whistle has been blown' but there is no time for a break."

"And let's not forget that the second half is usually more exhausting than the first, and we may even have to go into extra time," he added.

Weidmann singled out France and Italy, saying they needed to implement structural reforms to make up for lost competitiveness, urging them to act as a "role model" for crisis countries.

"If France for example were allowed, for the third time, to postpone the correction of its excessive deficit, this would severely undermine the credibility of the new Stability and Growth Pact," Weidmann said.

"If I may use another football metaphor, the Commission should stick to its role as referee and not try to move the goalposts mid-game." (Reporting by Marja Novak, writing by Eva Taylor; Editing by Hugh Lawson)