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Knot Says ECB to Keep Easy Policy

European Central Bank council member Klaas Knot said the euro’s exchange rate won’t affect the ECB’s economic forecasts and he expects the bank to maintain its accommodative monetary policy.

“The euro is, according to us, rather close to what the fundamentals would predict” and “surprisingly stable” in light of the unrest the region has been through, Knot, who heads the Dutch central bank, said today in Amsterdam. “So I see no special impact of the euro exchange rate on the predictions we made before.”

Knot’s comments echo those of ECB President Mario Draghi, who last week said that the euro is broadly in line with its long-term average. The ECB cut its forecasts on March 7 and now expects the 17-nation euro-area economy to contract 0.5 percent this year before growing 1 percent in 2014.

While ECB officials discussed cutting borrowing costs last week, the “prevailing consensus” was to leave the benchmark rate unchanged at a record low of 0.75 percent, Draghi said.

“Our monetary policy stance is very accommodative, has been accommodative for a long time and my expectation is that the sort of benign inflation environment for the coming months will allow us to maintain this accommodative stance,” Knot said at the presentation of the Dutch central bank’s annual report.

The ECB’s announcement of its Outright Monetary Transactions program has reduced bond-yield spreads in the region, “so that is also a marked improvement in the monetary transmission process,” Knot said.

Inflation Outlook

The ECB forecasts that inflation will slow to 1.3 percent next year, well below its 2 percent limit. Knot today dismissed fears of deflation risks in the euro area, saying the “inflation outlook is in line with our mandate.”

“There is for instance still sufficient price pressure in the production chain,” he said. “There is still the prospect of governments consolidating public finances also by VAT increases, leading to a sort of indirect inflation. We have absolutely no fear of deflation in the euro zone yet.”

The far-reaching measures taken by the ECB have increased the financial risks for the euro system, including for the Dutch central bank, Knot wrote in the annual report, noting the increase in the euro system’s balance sheet.

“At the same time, the money market is still rigid, market sentiment is still vulnerable, while the underlying tensions have not been solved and can easily increase,” Knot said.

Bond Purchases

The so-far-unused Outright Monetary Transaction program allows the ECB to buy bonds of member nations that request assistance and meet certain criteria.

“I think we have been crystal clear about the circumstances under which OMT can be activated. I don’t want to speculate on any specific case,” Knot said today. “It is clear if you communicate that certain circumstances are fulfilled, then the ECB should be ready for activation.”

The unconventional monetary measures the ECB has taken have worked out well, Knot wrote. “In general terms it can be concluded that inflation expectations have been anchored within the euro zone, while the fragmentation of the financial markets have been reduced,” he said. “A destructive scenario of deflation has been evaded.”

A two-day Brussels summit of European leaders starting today will endorse plans for “structural” assessments of national budgets, according to a draft statement, suggesting countries such as France, Spain and Portugal will be granted extra time to bring down deficits.

Knot said southern European countries need to stick “as much as possible” to a deficit-reduction path. “Only when the economy becomes worse than mentioned in the predictions, at a certain moment you reach a point on which you say that, at this specific moment, the effects can be more damaging than the positive effects,” he said.

To contact the reporters on this story: Corina Ruhe in Amsterdam at cruhe@bloomberg.net; Jurjen van de Pol in Frankfurt at jvandepol@bloomberg.net

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

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