PARIS (MNI)- The E1 trillion in 3-year funds that the European
Central Bank has injected into the Eurozone’s financial system is not an
inflation threat at the present time, and should that change the ECB has
the means to address it by withdrawing liquidity or raising interest
rates, Executive Board Member Benoit Coeure said Wednesday.

Given the Eurozone’s stagnating economy, demand is not sufficiently
strong to create inflationary conditions, Coeure noted in a speech
to the Association of French Corporate Treasurers. However, once banks
become less risk averse, they will start using their excess liquidity
for lending or to purchase riskier assets. This will in turn create
inflation pressure, first on assets and eventually on consumer prices,
“in the absence of an adequate monetary policy” response, he said.

Coeure noted that this dynamic and the speed with which it might
develop were difficult to know, “because long periods of excess
liquidity have not been frequently observed in the past.”

In any event, he noted, that there is nothing “impeding the ECB from
countering these effects by raising interest rates when the Governing
Council deems it appropriate.” And, he added, “the ECB has the
instruments necessary to absorb the excess liquidity should the
uncertainty surrounding its impact compromise the bank’s ability to
maintain price stability.”

Those instruments include collecting term deposits, as the ECB
currently does to sterilize its sovereign bond purchases; the potential
issuance of debt certificates; and a possible increase in bank reserve
requirement back to 2% from the 1% level to which it was reduced late
last year.

Coeure estimated that the excess liquidity in the system created
by the ECB’s two 3-year LTROs would remain constant about E800 billion
until at least January 2013, when banks that wish to do can begin
repaying the loans early.

He said that, far from being inflationary, the two jumbo operations
have thwarted the risk of deflation. In late 2011, just before the ECB
decided to launch the LTROs, the situation in financial markets was
“somber,” Coeure recalled.

“A vicious circle could have been born between the listlessness of
economic activity and the growing tensions in the financing of banks
and new reductions in lending, creating serious downward risks to price
stability,” he noted. “The measures taken by the ECB helped break this
chain of events and restore confidence in the Eurozone.”

Coeure noted that a number of market segments were now functioning
much better, including both securitized and non-securitized debt, bank
bonds and dollar-denominated issues.

“The situation in financial markets has reached a turning point but
the developments of recent days (in Spain and Italy) show how fragile
it remains,” Coeure said. “Everyone concerned must act in a responsible
manner to take the measures that are required.”

Coeure noted that because of the crisis the ECB’s balance sheet had
ballooned to E3 trillion, but he said that monetary-policy related
assets on the ECB’s balance sheet were still a smaller percentage of GDP
than was the case either for the US Federal Reserve of the Bank of
England. While the magnitude of the ECB’s risk has increased, the
“intensity” of risk has not. “The risk profile is unchanged,” Coeure
said.

— Paris newsroom; +33142715540; email: bwolfson@marketnews.com —

[TOPICS: MT$$$$,M$$CR$,M$X$$$,M$$EC$,M$S$$$]