July 25 (Bloomberg) -- European Central Bank council member Ewald Nowotny said there are arguments in favor of giving Europe’s rescue fund a banking license, reviving the debate on bolstering its firepower as leaders face the prospect of a full-scale Spanish bailout.
“I think there are pro arguments for this,” Nowotny, who heads Austria’s central bank, said in an interview in his office in Vienna yesterday. “There are also other arguments, but I would see this as an ongoing discussion,” he said, adding he’s “not aware of specific discussions within the ECB at this point.”
Granting a banking license to Europe’s permanent bailout fund, the European Stability Mechanism, would give it access to ECB lending, easing concerns that its 500 billion-euro ($602.5 billion) cash pot won’t be enough if Spain or Italy require aid. While ECB President Mario Draghi said on May 24 that such a move amounts to the central bank financing governments, which is prohibited by European Union law, publicly-owned credit institutions such as the European Investment Bank are exempt.
“It is not something that is only in the field of monetary policy, so this is part of a broad discussion,” Nowotny said. He declined to elaborate.
The euro rose for the first time in six days against the dollar and the yen after the comments were published, jumping more than half a cent to $1.2127 at 11:10 a.m. in Frankfurt. Yields on Spanish and Italian bonds declined while German bund yields rose.
The EIB, which was founded in 1958 and is owned by the member states of the EU, was granted access to ECB refinancing in July 2009. Nowotny said the fact that the ESM has missed a July deadline to become operational is a “weakness that has to be overcome.”
“Nowotny’s comments indicate that there is a debate, but they do not necessarily signal how that debate will be resolved,” said David Mackie, chief European economist at JPMorgan Chase Bank in London. If Spain and Italy lose market access, “the liquidity hospital would need to be redesigned, in terms of size, seniority and funding,” he said.
Spanish 10-year bond yields this week surged to a euro-era record above 7.6 percent, fueling speculation it may require a full-scale bailout. The ECB this month cut its benchmark rate to a record low of 0.75 percent and took its deposit rate to zero as the worsening economic outlook damps inflation pressures.
“Growth dynamics for the euro zone as such are tending to be lower than we had been expecting at the start of the year,” Nowotny said. “Inflation also tends to be lower, and what we see is that divergences in the economic dynamics between member countries of the euro zone unfortunately have a tendency to increase.”
While Nowotny didn’t rule out further downward moves in interest rates, which could involve lowering the deposit rate into negative territory, he said this “has to be decided at a later stage.”
“We do not have experience of course with negative deposit rates,” he said. “Some central banks are experimenting with this, for instance the Danish central bank. There might be some technical problems to applying negative rates for the deposit rate. For the time being this is not a practical aspect that is being discussed.”
Inflation will come down, Nowotny said, adding in a separate interview with Bloomberg Television that the ECB sees “no deflation perspective.”
Nowotny urged European leaders not to rush plans to construct a single European bank supervisor, which will likely result in the ECB assuming greater powers as the euro area attempts to break the link between failing banks and sovereigns. The European Commission is due to present proposals in September.
“I personally very strongly advocate that our first priority should be to build a high-quality, stable system,” he said. “Quality is more important than velocity.”
Nowotny said while he doesn’t consider that all of the EU’s 27 members would submit to the new single supervisor -- the U.K. being the most likely outsider -- large, cross-border institutions and smaller local banks should be overseen by the same regulator with powers to intervene when needed.
“For the smaller banks the prime operational side for technical reasons has to be with the national supervisors,” he said. “Only they have the manpower, the local knowledge, the direct access.”
At the same time, the ECB should have “the right to intervene in specific cases,” Nowotny said. “It is possible to have supervision out of Frankfurt, but you have to work with the local supervisors.”
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