Weber Says ECB Should Plot Out Exit in First Quarter (Update3)

By Christian Vits, Jana Randow and David Tweed
Aug. 20 (Bloomberg) -- European Central Bank council member Axel Weber said the ECB should help banks through end-of-year liquidity tensions before determining in the first quarter when to withdraw emergency lending measures.
“Most of these discussions about the continuation of the exit I think will be focused on the first quarter,” Weber, who heads Germany’s Bundesbank, said in an interview with Bloomberg Television in Frankfurt yesterday. “It’s clear that we need to re-embark on a normalization procedure.”
The euro dropped and the yield on Germany’s 30-year bond fell to a record low as Weber’s comments suggested the ECB will support the region’s banks for longer than some investors expected. Weber, the frontrunner to succeed ECB President Jean- Claude Trichet next year, also said there are no inflation risks in sight, indicating interest rates may remain on hold for some time.
“The comments are rather dovish, he seems to be very cautious,” said Juergen Michels, chief euro-area economist at Citigroup Inc in London. “I would have expected that he wanted to start the exit sooner.”
The euro fell more than a cent after Weber’s remarks were published to $1.2685, a five-week low. German government bonds erased their declines, with 10-year and 30-year yields dipping to record lows of 2.3 percent and 2.95 percent respectively.

Wisdom

The escalation of Europe’s fiscal crisis in May forced the ECB to halt its withdrawal of support for the region’s banks and reintroduce some tools, such as unlimited three-month loans.
Weber’s comments on the need to keep open the flow of emergency funds go beyond what Trichet has announced so far.
Weber said it would be “wise” to keep full allotment in weekly, monthly and three-month refinancing operations until after the end of the year, which is “usually surrounded by some uncertainty regarding the liquidity situation.”
Trichet has guaranteed unlimited seven-day loans, the main plank of ECB’s emergency policy, until Oct. 12 and unlimited three-month loans until the end of September. He hasn’t outlined the bank’s timetable after that.
Six-month loans should be allowed to expire and “I don’t think it would be wise to continue with these very long operations,” Weber said. Resuming the exit will depend on the “health of the financial system and the banking system,” he added.

Growth Revisions

The comments nevertheless indicate the ECB is growing more confident that the euro region is coping with its sovereign debt crisis after Germany powered the 16-nation bloc to its fastest economic growth since 2006 in the second quarter. By contrast, the Federal Reserve was this month forced to announce fresh measures to shore up a stuttering U.S. economy.
Weber, 53, said the ECB is likely to raise its euro-region growth forecasts next month after the German economy, Europe’s largest, expanded in the second quarter at the fastest pace since records for a reunified country began in 1991. The Bundesbank yesterday lifted its German growth prediction for 2010 to 3 percent from 1.9 percent.
“Since the second quarter outpaced our expectations the euro-area projections too are likely to be revised up as a result of the German performance,” Weber said. The euro-region revisions will be “more modest” than Germany’s because of weaker growth in some peripheral countries, he said.
The ECB in June predicted euro-area growth of 1 percent this year and 1.2 percent in 2011. Weber said there are no signs of inflation and indicated the ECB’s key interest rate is likely to remain at a record low of 1 percent for some time.

Rates on Hold

“Since inflation risks continue to be low over the policy- relevant medium term, this does not suggest a policy tightening yet,” he said. “Rates remain appropriate.”
Weber, who took the helm of the Bundesbank in 2004, said the drop in the German 30-year bond yield to a record low this week reflects a move into safe-haven assets and is not of concern. At the same time, it’s too soon to declare the financial crisis is over.
“We are in year four of the crisis and markets are still fragile,” he said.
Weber broke ranks with the ECB’s 22-member Governing Council in May when he opposed its decision to buy government bonds as part of a strategy to fight the Greek fiscal crisis.
While the purchases helped restore order to markets, yield spreads have recently widened again. The extra return demanded by investors to hold Spanish 10-year government bonds over German counterparts was at 180 basis points today compared with
164 basis points before the ECB began buying on May 10.

‘New Equilibrium’

Weber reiterated his opposition to the bond purchases, saying they pose stability risks, and expressed satisfaction that the program has been limited. The ECB has bought 60.5 billion euros ($78 billion) of bonds and purchases have dwindled in recent weeks.
“It is pretty clear that the purchase of government bonds has played a minor role only, it was a very modest number,”
Weber said. “What is happening is the market is re-pricing sovereign debt. I think any intervention in the market can smooth out the transition to that new equilibrium, but the market has to find that new equilibrium.”
Weber said “disappointing news” from some emerging markets and the U.S. had increased uncertainty in financial markets, and slower global growth will damp Europe’s recovery.
“But let’s not exaggerate, we’re not facing major problems,” he said. “The recovery is going to stay on track.
All in all, the picture looks much brighter than it did a year ago.”