MNI ECB SOURCES-2: Infl Target Debate Needed But At Later Date

By Christian Vits

     LONDON (MNI) - While there is some discussion in several national central

banks about the inflation development and whether the European Central Bank has

been pushed into a corner with its commitment to target 'below but close to two

percent', Eurosystem sources contacted by MNI believe that it is far to

premature to trigger a discussion about the bank's strategy.

     "That is something which might be discussed when we have ended all

extraordinary measures and find ourselves in the new normal," the first source

said. "The perception is that any discussion about the strategy would only yield

negative effects right now, for this reason such a fundamental debate is not on

the agenda."

     Still, there is quite a bit of discomfort about the current strategy: "Two

percent was set as an upper limit for inflation, but has transformed into a

lower limit as well," the second source said. "By all means, one could certainly

have the understanding that the upper limit is not the same as the lower bound."

     "The notion seems to become more and more established that a simple

fixation on 2% as the upper and the lower bound is not the way forward," he

added. "A strategy change is not taboo. But any change should be out of a

monetary policy conviction, not because of the situation we are in."

     --HANDLING THE STOCK

     Of other points for the Governing Council to focus on, there is the

question evolving of how to handle the stock of assets held. "This is a

discussion which has not even started yet, as it applies to the new normal.

That's a discussion not needed before 2019," the first source said. "It is in

question what instruments should be available, but no matter whether you use

them."

     However, liquidity supply is now completely different to the pre-crisis

situation. "There is no money market anymore," the second source said, "in

particular in the unsecured money market. I expect that over the medium-term,

banks' liquidity supply will be backed by central bank money."

     As a consequence, central banks such as the ECB will possibly hold parts of

the stock they bought. "First of all, one has to decide to leave a liquidity

buffer in the market." This might be E1 billion, or "about half of the current

balance sheet," according to the source.

     There has to be a landmark decision to follow such an approach. But

everything seems possible at the current juncture.

     "The mistrust between banks, the mistrust about unclear positions in

balance sheets has not lessened," the first source said.

     Any policy change in this respect won't happen before the negative interest

rate on deposits is reversed, the other source noted.

--MNI London Bureau; tel: +44 203-586-2225; email: les.commons@marketnews.com

--MNI Frankfurt Bureau; +49 69 97782671; email: christian.vits@marketnews.com

[TOPICS: M$X$$$,MT$$$$,MX$$$$,M$$EC$,M$$FI$]