ECB likely to hold rates

06/10/2009 | Sid Verma

Central bank's Erkki Liikanen stresses Europe's aneamic growth prospects

The eurozone is heading for a prolonged period of anaemic growth and is blighted by excess capacity, a member of the European Central Bank board member said on Tuesday, ahead of its monetary policy meeting on Thursday.

“There has been an improvement from a low [base] but it is very likely that the recovery will be sluggish,” said Erkki Liikanen, a member of the ECB’s Governing Council, said in an interview with Emerging Markets in Istanbul on Tuesday.

His comments strongly suggest the ECB will keep rates on hold at its October 8 interest rate meeting and caution that the risks to the global economy remain on the downside.

“All central banks need to prepare for our exit stimulus strategies” but monetary authorities can not say “when” they will do this, the Finnish central bank governor said.

With weak growth prospects and inflation expected to be low in the medium-term, Liikanen suggested a withdrawal of liquidity measures and monetary tightening would be premature.

“There are excess capacities in the economy and unemployment is still going up and this has impact on private consumption and investment,” he said.

Over the past year, the ECB has sliced 325 basis points from its main refinancing rate. The ECB meeting marks the first anniversary of the coordinated interest rate cuts by major central banks after financial catastrophe that was triggered by the mid-September collapse of Lehman Brothers.

He said a significant increase in capital raising by banks was a necessary but insufficient condition for financial stability, suggesting interest rates may be kept low to allow banks to issue equity.

“The banking system still needs to be well-capitalized and they [banks] still have impaired assets and that has an impact on the economy,” Liikanen said.

Nevertheless, he said the markets have bottomed out and cited the resumption of “inter-bank borrowing and corporate lending”, which are strong signals that the banking system has past the worst of the crisis.

Economists predict that the interest rates in the eurozone will not rise until the middle of next year at the earliest. Liikanen suggested that the pace of monetary tightening might be slow due to as firms readjust and repair balance sheets.

“Whenever some capacity will not be fully used and it takes more time to reinvest in new areas,” he said.

The World Bank estimates that excess capacity in the global economy will be as high as 6.5% below its potential upper level next year and it will take a further five years for it to improve to 2% below its potential upper level.

Justin Lin, chief economist at the World Bank said in Istanbul this weekend that “with this kind of underutilization of capacity, we expect that unemployment will continue to rise for some time ... and private sector investment will be depressed”.

Lin added: “This means the [global] recovery will be very weak and the foundation for the recovery is fragile.”

Liikanen also said structural growth prospects in the eurozone look bleak compared with a global bull run, due to the region’s demographic pressures.


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