ECB's Stark cautions against aggressive rate cuts

Reuters

Published: February 16, 2009

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By George Georgiopoulos and Marc Jones

Cutting interest rates aggressively now would risk exacerbating uncertainty given that the European Central Bank sees no risk of deflation, Executive Board member Juergen Stark was quoted as saying on Monday.

"Gradualism has remained a critical aspect of our monetary policy," Stark was quoted as saying in an interview with the Financial Times newspaper.

"Overly aggressive reductions in our policy rate when we cannot see any risk of deflation would exacerbate and not resolve uncertainty," he said.

In the last few months the ECB has undertaken the most aggressive series of interest rate cuts since its formation.

It has cut them by 225 basis points since October, bringing them down to 2.0 percent from 4.25 percent as it, like the rest of the world's central banks, battles the economic crisis.

ECB Governing Council member George Provopoulos spelt out just how bad the current situation is, describing it as the worst since the Great Depression of the 1930s.

"The outlook for the global and the euro area economy in 2009 appears dismal," he said as the Bank of Greece released its latest monetary policy report.

"The current crisis is the biggest since the 1930s and exiting from it will not be easy or quick."

Stark warned that a price stability-orientated central bank that acted only in response to fear risked losing credibility. But he also acknowledged that the ECB had to make optimal use of interest rate cuts.

"Yes, use the room for manoeuvre that is still available but not in a way that would put our reputation at risk," he was quoted as saying.

Asked whether the door was open for another significant interest rate cut on March 5, as analysts expect, Stark responded: "I will not exclude anything. However, it is also clear that a potential move, independently of its size, will reduce the room for manoeuvre in the future."

When asked again about the risk of deflation, he said that there was currently no sign that the bank would undershoot its target of keeping inflation just under 2 percent in the medium term, adding that inflation was expected to pick up in the second half of the year.

He was also cautious on whether the ECB would use more alternative monetary policy tools such as direct asset purchases -- a tactic already being employed by the U.S. Federal Reserve and the Bank of England.

"Some of the key measures adopted and applied by the Fed are based on Treasury guarantees so there is no or limited risk for the Fed. It is not feasible in my view to expect the ECB to do the same without government guarantees," Stark said.

RATE ROOM

The ECB is expected to cut euro area interest rates to a record low of 1.5 next month. But it would still leave them above countries such as Britain, the United States and Switzerland where policymakers have responded to the global financial crisis by slashing rates to record lows.

Stark said he remained wary about cutting rates to the bone.

"I would not call it dangerous. I would say it is not to be recommended and not advisable or desirable."

"Those who advise us to go to zero and then experiment at the zero level are not those who are responsible for the possible consequences," he said.

He said deflation was not on the cards in the euro zone at the moment, there was no knowing how financial markets would react to such low rates, while history showed that keeping rates that low for a lengthy period created its own problems.

It may also give banks little incentive to make vital changes, he added.

Gertrude Tumpel-Gugerell, a colleague of Stark's on the ECB's Executive Board, told an Austrian newspaper that the ECB was in the process of reviewing its economic growth forecasts.

"We are revising our forecasts for 2009 and 2010. In December we were still acting on the assumption of minus 0.5 percent for the euro zone. For 2010, growth of 1 percent was assumed. But since then a lot of things have changed," she told Austrian daily Wirtschaftsblatt.

ECB staff in December forecast the euro zone economy will shrink as much as 1 percent this year and grow between 0.5 to 1.5 percent in 2010. Inflation was projected to be between 1.1 and 1.7 for 2009 and 1.5 to 2.1 for 2010.

But analysts expect ECB staff to follow the likes of the International Monetary Fund and European Commission and slash their forecasts when updated numbers are published next month.

Tumpel-Gugerell added that recent interest rate cuts had made an impact on the economy.

"We have cut interest rates four times since October 2008. This has had a positive effect," she said, adding that the interbank market and borrowers had benefited from the rate cuts.