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MNI (London)

Eurozone interest rates may be too low and the European Central Bank could flip to hawkish mode if it needs to tighten policy earlier than anticipated in order to avoid strains on the financial system, the ECB's former head of financial stability told MNI.

The ECB currently assumes the neutral rate of interest is close to the deposit rate of -0.5%, Ignazio Angeloni, the ECB's Director General Financial Stability between 2012 and 2014, said in an interview, adding that policymakers could be forced to change to their view in a hurry.

"I personally believe the natural rate is positive, though perhaps lower than historically. If that is the case, it may be a bit imprudent to wait raising rates until inflation reaches the target, because that means you have to move up the rate rather quickly afterwards. That may generate volatility and give rise to financial stability problems."

Such considerations, he said, may explain the reservations of those governors who voted against July's change in forward guidance to promise to keep rates low until the ECB meets its new, more expansive inflation target.

"I think as the scenario evolves, the number of people having doubts in that respect may increase. At that point, the forward guidance may have to be adjusted," said Angeloni, who also served as a member of the ECB's supervisory board and is now a research fellow at the Harvard Kennedy School and a senior policy fellow with the Leibniz Institute for Financial Research SAFE at the Goethe University Frankfurt.

With recent inflation increases likely temporary, the ECB will probably avoid indicating it is about to taper its Pandemic Emergency Purchase Programme at its meeting on Thursday, Angeloni said.

But the Governing Council may be receiving less policy guidance from the Executive Board under President Christine Lagarde than it did under Mario Draghi, he said.


"That means you have to pay more attention to the balance of views among national governors. That may imply that national economic conditions become more relevant," he said.

When the ECB does move towards adjusting its guidance, its first move might be to remove its commitment to maintain purchases at a "significantly higher" pace than during the first months of the year. A decision on the future of EUR1.85 trillion PEPP may require a trade-off between hawks and doves, he said, and may not be imminent despite the approach of the March cut-off date for the active stage of the programme.

"The compromise may involve lengthening the duration of PEPP a little bit, but reducing the envelope, so it's more distributed over time," he suggested. "I would not expect that change to happen in September. I know that the market expects that now, but December seems to me a more natural time to assess how the situation has evolved and what the policy consequences should be."

MNI reported earlier in August that some officials think the ECB could debate extending the PEPP, and even expanding it by EUR500 billion. (see MNI SOURCES: ECB Bracing For September Debate On PEPP Future)

Germany's elections later this month could influence ECB decision-making, Angeloni said, with a win for parties supportive of relaxing spending and debt rules at home and in Europe potentially opening a path towards the rebalancing of fiscal and monetary policy.

If PEPP ends as scheduled, Greek sovereign bonds should continue to be included in ECB asset purchases, he said. But he was critical of ECB chief economist Philip Lane's suggestion that the volume of purchases under its Asset Purchase Programme should take government borrowing needs into account.

"Correlating APP to bond supply, especially across jurisdictions, goes very close to monetary financing of the fiscal deficit, which the EU Treaty explicitly prohibits," Angeloni said. "That would be a major change, which I would not expect to happen easily."

MNI Frankfurt Bureau | +49-69-720-146 |
MNI Frankfurt Bureau | +49-69-720-146 |

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