* Merkel says ECB’s situation tough given diverging economy
* Germany would need rate rise, others need even more liquidity
By Andreas Rinke
DRESDEN, Germany, April 25 (Reuters) - The European Central Bank would have to raise interest rates if it were looking at Germany alone but is in a difficult position because economic performance across the euro zone varies widely, German Chancellor Angela Merkel said on Thursday.
Merkel’s unusually outspoken comments on ECB policy come as the central bank appears to be closer to lowering interest rates than at any time since it last cut them in July 2012. It could shave a quarter point off rates next week.
“The ECB is obviously in a difficult position. For Germany it would actually have to raise rates slightly at the moment, but for other countries it would have to do even more for more liquidity to be made available and especially for liquidity to reach corporate financing,” Merkel said at a banking conference.
“If we want to get back to a bearable interest rate level, then we have to get over this internal division of the euro zone,” said the conservative chancellor.
The ECB sets interest rates for the whole of the 17-state bloc rather than tailoring policy to individual members states. An ECB spokeswoman declined to comment on Merkel’s speech.
The euro zone has slipped back into recession and inflation has slid well below the target of close to but under 2 percent for the bloc as a whole, giving the central bank scope to act.
But some economies in the core are performing well. Germany’s economy - Europe’s largest - is expected to grow by 0.5 percent this year and 1.6 percent next year, according to government forecasts released on Thursday. Low rates could have a negative effect on its output.
In some parts of the euro zone, small and medium-sized enterprises (SMEs) are struggling to get funding from banks, which are reluctant to take on further credit risk as they try to adapt to new regulation on capital and liquidity levels.
The ECB is increasingly concerned about this development as SMEs are key to getting the currency bloc back to growth but there is disagreement on how this can be addressed.
Merkel said the fact that companies in Portugal, Italy or South Tyrol face loan costs two or three times higher than in Germany meant they could not finance new investments, virtually “gobbling up” some of the countries’ reform efforts.
ECB policymakers believe looser policy would have limited impact on the euro zone economy - as lower rates do not feed through into the real economy every at the moment - but would at least show they are supporting it.
ECB board member Joerg Asmussen said on Thursday that looser policy could not solve the crisis and that were interest rates too low for too long, it could eventually lead to distortions.
“Monetary policy is not an all-purpose weapon for any kind of economic illness,” he said. “Due to impaired monetary policy transmission, the pass-through of rate cuts to the periphery would be limited, and this is where they are most needed.”
The ECB’s Governing Council meets in Bratislava next Thursday - one of two annual policy meetings outside Frankfurt. The 23-man body rarely moves rates when it meets off-base but the bleak economic picture strengthens the case for action.