January 21, 2009 / 12:12 PM / 10 years ago

UPDATE 2-Trichet dismisses deflation, euro break-up risk

BRUSSELS, Jan 21 (Reuters) - European Central Bank President Jean-Claude Trichet played down the threat of deflation on Wednesday, as he hinted at further interest rate cuts and dismissed speculation about a euro zone break-up.

Trichet said that while the central bank was wary of cutting interest rates too low, policymakers had not said the current 2 percent setting was the lowest level. [ID:nFAT004550]

Speaking to a committee of the European Parliament, he also minimised the threat of deflation — a sustained fall in prices — and instead welcomed the recent sharp slump in euro zone inflation.

“There is presently no threat of deflation,” he said. “What we are currently witnessing is a process of disinflation, driven in particular by a sharp decline in commodity prices.”

The ECB chief also rebuffed suggestions that some countries may be looking to quit the euro zone after the recent financial turmoil and downgrades to Greece and Spain’s credit ratings.

“I think these rumours are unfounded about the euro,” Trichet said.

However, markets have begun to bet on the once unthinkable — that the euro zone might break up.

Prices of insurance against debt default by Ireland, Greece, Italy, Spain or Belgium have jumped in recent weeks and yield spreads against German Bunds have ballooned, as doubts increase about some governments’ ability to pay for multi-billion euro economic stimulus packages.

“Of course in the financial markets banks have to determine their own level of risks,” said Trichet.

“Governments are responsible for their policies ... they have to do all (that is) necessary to cope with the situation.”

“The current economic situation calls for prudence with regard to the adoption of extensive fiscal stimulus measures.”

DIFFICULT YEAR

ECB Governing Council member John Hurley also hinted the ECB could cut interest rates as he predicted a severe economic slump this year.

“If inflation expectations are revised, the ECB is ready to act,” he told an Irish parliamentary committee.

A new Reuters poll [ECB/INT] showed economists have also slashed their economic forecasts although the majority are not as pessimistic as recent official forecasts.

A poll of 47 economists showed the economy is expected to contract by 1.6 percent this year, twice the 0.8 percent fall seen in last month’s poll, but slightly better than the 1.9 percent contraction forecast by the European Commission on Monday.

In Brussels, Trichet acknowledged the region was suffering.

“The year 2009, as was said by the (European) Commission recently, will be difficult ... the pick-up should take place in 2010.”

“We have to do all we can to help the revival of the financial sphere and real economy,” he said.

He also repeated calls for a major overhaul of the financial system. “We need to reform everything, leave no stone unturned,” he said.

“The financial architecture requires a strengthening of the informal groupings, in particular the Financial Stability Forum and the G20,” adding the International Monetary Fund also had a major role to play.

Speaking in the Middle East, French central bank governor Christian Noyer added to the debate but admitted it may be impossible to find a perfect one-size-fits-all solution.

“This crisis has shown the merits of having the banking supervisor close to the central bank,” Noyer said in a speech in the United Arab Emirates.

“The point is not to claim there is an optimal supervisory structure that fits any country’s circumstances. Rather it is to note that a system such as the one we have in France has proved very useful”.

Trichet also played down the chance of the ECB copying the U.S. Federal Reserve’s example of buying up debt as an alternative way of boosting the economy.

“At the present moment we trust that this is not something that we should engage in, but as I said we are permanently alert.”

He was also sceptical about the idea of creating an international “bad bank” into which the world’s banks would dump their toxic assets, saying such a move would not be appropriate.

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