Feb. 24 (Bloomberg) -- European Central Bank Executive Board member Benoit Coeure said a policy of zero or negative interest rates create “significant costs” that aren’t needed given the outlook for inflation.
“The costs of an anticipated protracted low-rate policy -- in terms of fueling risk taking, promoting an overhang of non- performing loans and prolonging future imbalances -- can be significant,” he said in a speech delivered in Miami on Feb. 19 and released by the Frankfurt-based ECB today.
The ECB held its benchmark interest rate at a record low of 1 percent this month as President Mario Draghi signaled the economic outlook had improved. The ECB will allot its second offering of three-year loans on Feb. 29 to relieve liquidity strains in the region as officials work to contain fallout from the sovereign debt crisis.
Calls for the central bank to put its key rate at zero or lower as part of its crisis-fighting arsenal pose a risk that banks “become addicted to central bank credit,” Coeure said. “A switch to zero or negative interest rates bears some risks” that are “warranted only in the face of clear downward risks to price stability, which today are not present in the euro area,” he said.
He said the economy in the euro area will recover “very gradually” this year while inflation will stay above 2 percent “for several months to come.” Inflation held at 2.7 percent in January, above the bank’s aim to keep annual consumer price gains just below 2 percent.
Cutting borrowing costs to zero or less and leaving them there for an extended period could drive intermediaries such as money markets out of business and encourage lenders to dismantle their trading operations, Coeure said. It may also discourage banks from repairing balance sheets, or undermine their profits and lead to a credit contraction.
“The belief that interest rates will stay low for long periods might lead banks to make excessive liquidity promises and increase the future need for low rates, and thus sow the seeds of future crises,” Coeure said.
The central bank’s non-standard measures to battle financial turmoil include providing unlimited long-term liquidity through reverse repurchase agreements, where the funding cost is determined “as economic conditions unfold,” he said.
It is “crucial that the implementation of these measures does not hamper the chances of reviving currently dysfunctional market segments, such as the interbank market,” he said.
--Editor: Craig Stirling
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