Low ECB rates could raise risk of abrupt surge in risk premia: Weidmann

ELTVILLE, Germany (Reuters) - An extended period of low European Central Bank interest rates could increase the risk of a sudden surge in risk premiums, and policymakers should consider the implications of financial imbalances, Bundesbank President Jens Weidmann said on Friday.

President of the Deutsche Bundesbank Jens Weidmann speaks during a meeting in Rome, Italy April 26, 2016. REUTERS/Tony Gentile/File Photo

His comments coincided with German Finance Minister Wolfgang Schaeuble and another senior lawmaker in Chancellor Angela Merkel’s conservative party renewing their criticism of the ECB’s ultra-loose monetary policy.

The ECB expects its key rate to stay deep in negative territory for years, potentially increasing risk-taking and inflating asset bubbles as investors are forced to turn away from fixed-rate securities to seek returns.

This has raised concerns that bubbles could burst or that the eventual end of ultra-loose policies could trigger a sudden market reversal.

But policymakers have tended to play down stability concerns, arguing that no bubbles are evident for now and the ECB’s main task is to meet its inflation objective.

“They (asset managers) might become increasingly nervous the longer monetary policymakers try to maintain the low-interest-rate policy,” Weidmann told a conference. “This, in turn, could raise the probability of a sudden hike in risk premiums, the longer that forward guidance is in place and the more aggressively quantitative easing is pursued.”

Weidmann added that the ECB should not ignore the potential market exuberance created by its exceptional stimulus because the macroprudential tools meant to fight such imbalances were new, incomplete and not fully understood.

“While I am not in favor of a dual monetary policy mandate, I am convinced that monetary policy cannot stand on the sidelines when financial imbalances build up,” said Weidmann, who sits on the ECB’s Governing Council. “Monetary policy would be wise to take the implications of financial imbalances for price stability into account.”

He said the first defense against imbalances should be strengthening banks, and called for new regulations to discourage lenders from holding debt of other financial institutions that was subject to bail-in rules.

The ECB has faced intense criticism from German politicians, who have complained that ultra-low rates are creating a “gaping hole” in savers’ finances and pensioners’ retirement plans as returns have dropped.

“The German government thinks low interest rates should remain a temporary phenomenon,” Schaeuble was quoted as saying by the daily Handelsblatt in its Friday edition.

He said the government was monitoring the negative effects of low interest rates.

Ralph Brinkhaus, deputy parliamentary floor leader of Merkel’s conservative bloc, told Deutschlandfunk radio that the ECB had “pretty much stretched” its mandate, in the process eroding Germany’s trust in it.

Reporting by Balazs Koranyi; Editing by Kevin Liffey