ECB fearful of overly low rates, eyeing debt buys
News Article Date: Thursday 04th of December 2008
European Central Bank President Jean-Claude Trichet talked of the bank's fears of cutting rates too low on Thursday and said it was looking at alternative ways to boost the system such as buying debt.
The ECB cut rates by a record 75 basis points but Trichet said policy makers were worried that cutting rates too low could create serious problems by making it too difficult to raise them to sensible levels again.
"At the moment I would certainly say yes (there is a limit to how low rates could be cut). We have to be aware of being trapped at a nominal low level," he said at a news conference.
With those fears in mind he said that ECB was looking at alternative ways to boost health of the financial system.
He said one of the options would be to follow the U.S. Federal Reserve and look at buying up government or corporate debt such as bonds as an alternative way of getting liquidity into the system.
Such a move would be aimed at lowering yields to stimulate demand and mirror the approach of the Bank of Japan in the early part of this decade as it struggled with deflation.
"We took note that when asked whether the ECB could buy private or government-owned paper that Trichet said "I think it is possible," said RBS economist Jacques Cailloux.
"We think the first possible unconventional policy measure would be the purchase of private paper, something which could be implemented while the policy rate remains well above the zero percent bound."
Juergen Michels at Citigroup struck a similar tone. "If short-term interest rates reach their lower bound and financial conditions remain tight, the ECB probably will use unconventional measures," he said.
"In our view, the ECB is more likely to start with broadbased asset purchases rather than giving verbal commitments to leave rates low for a long time."
Euro zone government bond yields are at multi-decade lows but the cost of protecting German and Italian government debt against default jumped to a record high on Thursday, according to data monitor CMA DataVision, as investors fretted about the size of government borrowing to fund financial bailout packages.
Cailloux warned buying up the debt would be difficult for the ECB to orchestrate.
"This would have the potential to lower dramatically the spreads on these instruments. However, the difficulty of these operations are many, including the choice of the instruments to buy (given that there is not any uniform market in the euro area) and the side effects these purchases could have (crowding out effects on other instruments not falling under the purchase program for example)," he said.
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