ECB's Honohan Welcomes Government Bond Purchases as `Important' New Tool

European Central Bank council member Patrick Honohan welcomed the bank’s government bond purchases as an “important” new weapon in its armory and said any risks associated with the policy are being managed.

“This has been an important extension, a use of tools that haven’t been used before,” Honohan, who is also head of Ireland’s central bank, said in an interview in his office in Dublin on May 28. The decision “was exactly the right kind of prompt initiative” needed, he said.

The ECB’s asset purchases are part of a European bid to rescue the euro after budget blowouts in Greece, Portugal, Spain and Ireland triggered a sovereign debt crisis. Not all of the central bank’s 22 policy makers support the bond program, with Germany’s Axel Weber openly criticizing the move for its inherent “stability risks.”

Honohan, 60, who joined the ECB’s Governing Council in October last year, said he’s “solidly behind” the decision to buy assets. “It’s not in the normal course of the ECB’s traditional approach to a toolbox, but it’s not outside the range of the toolbox of standard central banking around the world in history,” he said.

Budget Deficits

“There’s obviously a divide within the council,” said Karsten Junius, a senior economist at Dekabank in Frankfurt. “It’s controversial because they’re not sure how to get out of it and it’s not clear where it’s going. Still, we don’t know whether risks would have been even bigger without the program.”

Ireland’s budget gap widened to 14.3 percent of gross domestic product last year, more than four times the European Union limit. Germany’s was 3.3 percent. The yield premium investors demand to buy Irish debt over comparable German bonds, the European benchmark, was at 215 basis points today. It widened to 306 basis points before the ECB announced its bond- purchase plan on May 10.

The ECB’s announcement came hours after European leaders unveiled a 750 billion-euro rescue package to contain the fiscal crisis. While the ECB says its aim is to restore normal functioning on markets, the purchases have exposed it to claims it is financing profligate nations at the behest of governments.

The program entails “stability risks” and “must be precisely targeted and limited,” Weber, who heads Germany’s Bundesbank, said earlier today.

‘Very Effective’

The ECB bought 35 billion euros ($43 billion) of bonds in the first three weeks of the program. It is countering the effect on money supply by draining the same amount of liquidity through one-week deposits from banks.

“It’s a very effective way of ensuring that it doesn’t leak over and have an impact on overall average liquidity conditions,” said Honohan, previously an economics professor. He declined to say whether the ECB has already started purchasing private-sector debt or whether there’s a timeframe for the bond program.

“We can consider it on an ongoing basis,” he said. “It’s been operated in a very professional, effective way.”

As the mounting debt crisis undermines confidence and forces countries to step up spending cuts, threatening growth, economists say they don’t expect the ECB to increase its main interest rate from a record-low 1 percent anytime soon.

Goldman Sachs Group Inc. on May 24 pushed back its forecast for the first increase to the second quarter of 2011 from the first.

Euro Area ‘Safe’

“It seems to me that the current stance of interest rates can hardly be questioned,” Honohan said. “The events over the last couple of weeks have not brought forward the likely increase. It’s not surprising that markets would react in this way and I suppose without necessarily endorsing exactly what the market is doing, one has to be realistic.”

Honohan also said the euro area is “safe” and he expects it to continue to expand.

“I don’t have any doubt in my mind that the euro and the euro area are permanent features of the landscape,” he said. There have been “pressures” on markets, “but not in a way that makes any difference to my firm opinion that the euro will continue to have an even growing membership of countries.”

So far, investors seem unconvinced by the efforts of the ECB and European governments. The euro has slumped 14 percent against the dollar this year on concern rising budget deficits will lead to a default by a euro-area nation and a possible breakup of the single currency union.

“Restoring market confidence in the solidity of governments’ finances is absolutely crucial,” Honohan said. “Doomsday discussions are actually beside the point because governments have committed themselves to viable fiscal plans.”

The ECB will hold its next rate decision on June 10 in Frankfurt. The central bank that day will also publish its latest economic forecasts.

To contact the reporter on this story: Simone Meier in Zurich at smeier@bloomberg.net

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