MNI INTERVIEW: ECB Risks Losing Credibility: DIW's Fratzscher

--ECB Needs To Reassess Mandate, But Not Lower Target, Former International

Policy Head Says

--No Rate Hike Seen Before 2021

By Luke Heighton

     BERLIN(MNI) - The European Central Bank risks losing credibility if it

continues to miss its 2% inflation target, its former Head of International

Policy Analysis told MNI, adding that he did not anticipate any interest rate

rises before 2021 and that central banks should communicate less.

     "Low inflation is not specific to the euro area," Marcel Fratzscher said in

a March 18 interview in Berlin, "but it is very dangerous, because the

credibility of a central bank depends on its ability to meet its mandate."

     Fratzscher, identified by the German press as a potential head of the

Bundesbank and currently president of the independent German Institute for

Economic Research, known as DIW Berlin, was commenting on a recent call for a

review of ECB monetary policy strategy by Finnish central bank governor Oli

Rehn, who fears trust in central banks' ability to influence inflation is being

eroded.

     "I wouldn't say the ECB has low credibility," said Fratzscher, who left the

ECB after more than a decade in 2012. "It has a high credibility, but one should

not underestimate the risks if a central bank misses its mandate for too long.

We need a strategic review of the mandate, but please do not use it as an easy

way out of the dilemma and lower your inflation target."

     Prospects for the ECB meeting its prices target dimmed further in March,

when the Bank cut its 2019 inflation forecast to 1.2% from 1.6%, and slashed its

growth outlook. The eurozone's recovery is lagging that of the U.S. by four to

five years, Fratzscher said, adding that the neutral level of interest rates may

have fallen to around 3%, from 5%-6% in the past. Any ECB tightening remains a

long way off.

     "My hunch is we won't see the first step on the policy rate before early

2021. On the deposit rate it could be that if things really go well next year

that it will be taken back closer to zero in one step or two."

     --TLTRO SURPRISE

     Fratzscher said he was surprised by the ECB's March 7 announcement of a

third round of targeted longer-term refinancing operations.

     "On the one hand, I thought 'Wow, the ECB is a lot more worried than I was

so far,' so the risks must be absolutely gigantic," he said. "The second,

positive element, was to say that the ECB wants to be ahead of the curve, and it

is acting now rather than later."

     A return to quantitative easing would be an option should the eurozone

economy continue to weaken, Fratzscher said, adding that limits on the amount of

bonds the ECB can buy from individual issuing countries could be extended. It

could also broaden its purchases of private sector assets, he said.

     "It would be very unpleasant for the ECB if it had to revert back to

further non-standard measures, but I think it would do it."

     Fratzscher said that the ECB "has done fairly well" in its use of forward

guidance, but that this be would be better if it were less explicit and more

conditional, even if markets do not like, or want to understand, conditionality.

     "The big risk of forward guidance is that markets get hooked, they don't

consider their own private information any more, and they become too focused on

what the central bank is telling them. My hope is that the ECB will provide a

bit of forward guidance on the interest rate until the end of the year, but then

stop doing it," he said, adding that this would depend to some extent on their

ability to reach their inflation target.

     "I think that, not just for the ECB but for most central banks, there has

been too much communication over the last 10 years, that central banks have been

too dominant."

--MNI London Bureau; +44 203 865 3829; email: jason.webb@marketnews.com

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