European Central Bank Executive Board member Benoit Coeure said banks may not need another round of the cheap long-term loans that were key to fighting the euro-area debt crisis and recession.
“It may be the case that the standing facilities are enough to ensure an appropriate level of liquidity; if this is not the case, then we would act,” Coeure, who responsible for money markets at the ECB, said in an interview in Frankfurt yesterday. “Tail risks are much more limited today than six months ago. So to that extent, we’re more confident in the recovery.”
Coeure’s stance signals the ECB sees a day when financial markets can cope without the long-term refinancing operations, or LTROs, that warded off a credit crunch two years ago. At the same time, he stressed that the central bank is still guaranteeing lenders as much short-term cash as they need until at least July 2015, after the current 3-year loans expire.
“There is not enough recognition in the market of the power of the fixed-rate, full-allotment regime,” Coeure said, referring to the bank’s crisis-era policy of meeting all demands for liquidity. “That’s an important backstop for the market and that worked effectively at the end of last year.”
Coeure said the importance of the backstop was illustrated in December, when overnight borrowing costs for banks surged to the highest level in two years. He said institutions coped by accessing standard ECB refinancing facilities that offer cash for periods from one week to three months, signaling that they’re now better able to withstand temporary shocks.
“We had very tight liquidity and elevated Eonia and Euribor rates; that’s something we wouldn’t like to see as a permanent situation,” said Coeure, 44, who sits on the ECB’s six-member Executive Board that implements policy and votes on measures as part of the decision-making Governing Council. “It’s not new that we’ve been worried by possible upward shifts in our money-market curve.”
The overnight lending rate was at 0.21 percent yesterday, down from 0.45 percent on Dec. 31. The euro fell as low as $1.3598 after Coeure’s comments were published, compared with $1.364 earlier.
Excess liquidity in the euro area, the surplus cash in the financial system that isn’t immediately needed by banks to meet their obligations, fell to 131 billion euros ($179 billion) yesterday. That’s the lowest level in more than two years.
The ECB is ready to act if external events such as the U.S. recovery spur volatility in European money markets, Coeure said.
Rates climbed in the middle of last year after the Federal Reserve said it would start tapering its stimulus to the U.S. economy. The Fed reduced its monthly asset purchases to $75 billion this month from $85 billion and Chairman Ben S. Bernanke has said further cuts are likely at each Federal Open Market Committee meeting this year. The next gathering is scheduled for Jan. 28-29.
“We want to make sure that monetary conditions, including money-market rates in the euro area, remain appropriate to the situation,” Coeure said. “So far, the European market has shown a good deal of resilience and capacity to disconnect from U.S. developments, which is welcome because it’s consistent with the state of the euro-area economy. But it’s something that needs to be monitored very closely.”
The ECB’s eye is also on any threat to the medium-term outlook for euro-area inflation, which the Frankfurt-based central bank says should converge back to its target of 2 percent as the economy revives. The pace of annual price increases in the region dropped below 1 percent in October, stoking fears that deflation isn’t far away.
“We are absolutely clear, looking through short-term developments, that we are serious about our inflation objective and that it’s a symmetric objective,” Coeure said.
While Coeure reiterated that the ECB has multiple policy instruments to deal with different scenarios, its main refinancing rate -- the tool with which it has traditionally steered the short-term cost of money for the rest of the economy -- is already at a record low of 0.25 percent.
Coeure signaled that reductions of less than the normal step of 0.25 percentage point are technically possible, and confirmed that policy makers are also prepared to start charging banks if they hoard money away from the economy by parking it at the ECB. The deposit rate is currently at zero.
“From a purely operational point of view, I don’t see a binding limit to where we can go if need be, and we’ve been clear that the deposit facility can go negative,” he said. “It is probably possible for a fraction of the money market to trade at negative rates.”
Another tool is ECB President Mario Draghi’s pledge to keep borrowing costs at or below current levels for an extended period. The promise was first made in July and strengthened this month, when he said the Governing Council “firmly reiterates” its forward guidance and “strongly emphasizes” that it will maintain an accommodative monetary policy.
“We would certainly be ready and willing to strengthen the forward guidance in the sense that we are absolutely clear that further downside risks to the current scenario would be taken into account,” Coeure said. “We have been clear on that and we would be very happy to be even clearer if needed.”
In contrast to other major central banks, the ECB has stopped short of providing details on its commitment, giving room for speculation about just how long interest rates will stay suppressed. Defining thresholds for inflation or unemployment that would trigger a policy change is difficult in the 18-nation euro region, Coeure said.
“We don’t know enough about the functioning and the structural change the euro zone is going through to put numbers on our reaction function,” Coeure said. “We don’t know much about future trends in productivity, the functioning of labor markets and the degree of price rigidities in the euro area.”
Euro-area unemployment remains stuck at a record 12.1 percent and countries from France to Italy are struggling to grow. Bank lending to companies and households has contracted for more than 1 1/2 years, weighing on the euro area’s recovery from its longest-ever recession.
Publishing an account of the Governing Council meetings, or minutes, may provide some transparency on the ECB’s deliberations on economic scenarios and policy instruments. After embracing the idea in August, Draghi said last week the Executive Board will make a proposal to governors soon.
Publication would “serve monetary policy and make it more effective by helping markets and the public to understand monetary policy better, understand better what are the options and the risks, and with that anticipate better what we can do and not do,” Coeure said. “I personally stand on the side of those who think the individual votes should be published.”
Coeure said that whatever unprecedented policies the ECB uses, they shouldn’t be considered normal or permanent. The euro area will recover and financial-market fragmentation, which hinders low official rates from reaching the real economy, will gradually subside.
“Everything we’re doing now is temporary; it has to end at some point,” Coeure said. “The time is not ripe yet for normalization, but it will have to come and when it comes, that will be good news.”
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