September 14, 2018 / 8:45 AM / a year ago

UPDATE 1-ECB can't ignore stability risk from low rates - Smets

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BRUSSELS, Sept 14 (Reuters) - The European Central Bank will wind down stimulus only very slowly and should not ignore the risk to financial stability that a lengthy period of ultra low interest rates may create, Belgian policymaker Jan Smets said on Friday.

Record low rates and massive money printing by central banks have been blamed for fuelling bubbles in some bond and real estate markets even if ECB policymakers have maintained that these are isolated pockets.

Smets argued that low rates and unconventional monetary policy were here to stay but he added that it would be naive to think that financial stability was totally independent of monetary policy, so there was a role for central banks to play.

Such a view suggests that Smets may see a bigger role for the ECB than board member Yves Mersch, who last week said that political institutions are better suited for maintaining financial stability and the ECB should have only an advisory role as its primary objective is price stability.

“It is natural to see central banks playing an important role here,” Smets, who sits on the ECB’s rate setting Governing Council, told a conference. “It would be naive to think that monetary and macroprudential policy are two fully independent instruments, as they both act through the financial system,” Smets said. “I think the future of central banking also lies in learning more about possible interactions.”

Still, like Mersch, Smets argued the primary focus should be the ECB’s inflation objective and prudential policies should be the first line of defence against financial instability.

But rates are likely to stay low for an extended period of time, Smets argued, suggesting that in the future they are likely to hit zero more frequently, forcing the ECB to rely on unconventional tools.

“The steady state real rate – often referred to as the natural rate – has dropped and that is, I think, one of the important features of the new normal,” Smets said. “Active use of the central bank balance sheet and forward guidance will very likely become more standard instruments in our toolkit.” (Reporting by Francesco Guarascio Writing by Balazs Koranyi; Editing by Janet Lawrence and David Stamp)

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