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Markets News

WRAPUP 1-ECB won't breed dependency on cheap cash -Trichet

* Delayed exit from support would distort behavior-Trichet

* No low rate pledge needed -Trichet

* Worth looking at collateral framework -Trichet

FRANKFURT/NEW YORK, March 12 (Reuters) - The European Central Bank is committed to continuing to gradually phase out emergency lending in order to prevent banks from becoming dependent on central bank funds, President Jean-Claude Trichet said on Friday.

In a speech to an economics summit in California, Trichet said money markets were now back in balance and the ECB aimed to return eventually to its pre-crisis liquidity offering.

“We do not wish to breed dependency,” he said in a speech at Stanford University in California.

“While we monitor the conditions for a gradual phasing-out very attentively, we are convinced that a delayed exit from extraordinary liquidity support would distort market behavior and misallocate credit.”

The ECB took further steps last week to pull back its liquidity lifeline, returning three-month lending operations to an auction procedure but prolonging unlimited funds at fixed rates for shorter-term loans until October. [ID:nLDE62307B]

The ECB concluded at its March 4 policy meeting that the present exit pace was “appropriate” given signs of economic recovery and improving financial market conditions, Trichet said.

Term lending had resumed on a satisfactory scale, banks’ funding ability was not hampering lending and corporate and bond spreads had declined steadily.

Benchmark market rates remain at historic lows despite the ECB's exit EURIBOR= and Trichet said current ample liquidity meant financing conditions would stay favorable.

Several ECB policy makers have suggested the ECB should make the one-month lending operations introduced during the crisis a permanent feature, but Trichet said he saw little need for major changes to the ECB’s liquidity operations.

“What is our end point? We view the pre-crisis operational framework as a very natural reference point for the phasing-out process,” he said, adding the ECB was reviewing potential lessons from the crisis for its policy design.

“It seems to me, however, that in this respect the ECB has relatively little reason to change fundamentally what has served our monetary policy well, both in normal and crisis times.”

NO RATES PROMISE NEEDED

Many investors and analysts have pushed back bets for the ECB to start raising official rates into 2011, compared with earlier expectations for the end of 2010.

Trichet said that rates would be set with the sole aim of delivering price stability, defined as inflation of below but close to 2 percent.

The ECB had kept inflation expectations close to this level and therefore had been able to keep inflation-adjusted interest rates in positive territory -- also meaning it had no need to make promises about its future rates path, he said.

This contrasts with the approach followed by the U.S. Federal Reserve, which has said it will keep rates close to zero for an “extended period.” [ID:nN10148647]

In an interview with Bloomberg Radio on Friday, Trichet said the ECB should look at whether it is worth amending its collateral rules.

A fellow ECB policy maker, Axel Weber, earlier this week floated the idea of higher risk margins for lower-rated bonds submitted by banks as security for loans, after criticism about the pivotal role assigned to ratings agencies in deciding which assets can be used as collateral for central bank loans.

“Absolutely, we have to look at this particular issue,” Trichet said.

Trichet also on Friday, in a Fox Business Network interview, said the steps Greek Prime Minister George Papandreou has taken to address the country’s fiscal crisis have been courageous and will convince markets the country is moving in the right direction.

In the same interview, Trichet said it was worth looking in more detail at a proposal to create a European Monetary Fund, but said any fund should be created by member countries’ governments.

“We have seen the proposal. I would say it deserves examination,” Trichet said about creating a body for European nations akin to the International Monetary Fund.

Executive branches of the member countries’ governments would have to create the fund, with a “very, very strong conditionality” placed on it, he said. (Additional reporting by Steven C. Johnson in New York and Lisa Lambert in Washington; Editing by Leslie Adler)

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