ECB Rejects IMF Call for Lower Rates Citing Broken Transmission

European Central Bank officials rebutted calls by the International Monetary for lower interest rates, citing a broken transmission channel and the absence of deflationary risks.

“I’m not saying it won’t happen but right now” interest rates “are appropriate,” ECB Vice President Vitor Constancio said in an interview in Tokyo today. “I don’t see risks of deflation. Our internal analysis doesn’t show that.”

The IMF said yesterday the ECB has “ample justification” for keeping interest rates low or cutting them further amid risks of falling prices. While the Frankfurt-based ECB reduced its benchmark interest rate to a historic low of 0.75 percent on July 5 and took its deposit rate to zero, President Mario Draghi signaled last week that further easing may have only a limited effect on the economy.

“The precise point of the policy rate at the moment is less important than the transmission of our policy,” ECB Governing Council member Christian Noyer told reporters in Tokyo today. “For us the major problem is first, fix the transmission problem. Once we fix the transmission problem, we shall see if the rates are appropriate, but it’s not really the major issue at the moment.”

Unlimited Support

The ECB decided to design a new bond-purchase program, dubbed Outright Monetary Transactions, “because we cannot accept that monetary policy is totally blocked” by distorted bond markets, Noyer said.

JPMorgan Chase Bank NA economists including Bruce Kasman have “removed all further rate cuts from our forecast,” they said in a research note dated Oct. 5. “To the extent that its OMT program significantly improves the regional transmission mechanism,” the ECB “feels less pressure to cut rates,” they said.

Policy makers have in the past weeks worked on details of the new plan that pledges unlimited support to debt-strapped nations if they sign up to economic reforms as part of a bailout from Europe’s rescue fund. The program has helped alleviate market tensions and provides a “fully effective backstop” to prevent a euro breakup, Draghi said yesterday.

Constancio said the ECB has “worked out all the details” and is ready to implement the program.

Two Components

“We want this to be as efficient as possible and for that we need the two components -- our program and the countries complying,” he said. “We couldn’t do it alone just by having our leg of the program implemented.”

Spanish Prime Minister Mariano Rajoy, who meets his French counterpart Francois Hollande in Paris today, has said he is still weighing up whether his country needs a bailout since the ECB’s safety net has already offered investors some reassurance and lowered borrowing costs.

Since Draghi’s pledge to do whatever it takes to save the euro, the yield on Spain’s 10-year bond has fallen from above 7.6 percent to 5.88 percent today.

Rajoy is struggling to meet his EU commitments for reducing the country’s budget deficit. The IMF this week forecast that Spain will miss its targets for the next three years.

“Fiscal consolidation can’t work if it isn’t accompanied by changes in the structure of the economy,” ECB Governing Council member Ignazio Visco said during a panel discussion in Tokyo today. “You have to convince investors that what you’re doing on the structural side is going to work.”

Euro Breakup

Speculation about a euro breakup is founded exclusively on investor concern about the credibility of governments’ reform efforts, Visco said.

The ECB’s insistence on conditionality for bond purchases today won praise from officials attending the IMF’s annual meetings in Tokyo.

The structure of the ECB’s OMT program is “exactly right,” the lender’s No. 2 official, David Lipton, said during a panel discussion. Laurence D. Fink, chairman and chief executive officer of BlackRock Inc., said the policy will “stabilize” tensions in the region.

Constancio said the ECB will keep its word on renouncing seniority in any future debt restructurings that involve bonds purchased under the new program.

“We will be, with regard to the OMT program, treated as any other investor,” Constancio said. “It’s our word. I don’t think that you find central banks reneging on their word.”

With the decision to accept losses in the future, the ECB wanted to “eradicate fear” that other countries will follow Greece in restructuring its debt, Noyer said.

“There was the strong belief that Greece was a unique case and there would not be another restructuring in the euro zone,” he added.

To contact the reporter on this story: Jana Randow in Tokyo at jrandow@bloomberg.net

To contact the editor responsible for this story: Craig Stirling at cstirling1@bloomberg.net

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