Sluggish economy prompts QE rethink at Germany's Bundesbank

The entrance of the Bundesbank headquarters is pictured in Frankfurt

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The entrance of the Bundesbank headquarters is pictured in Frankfurt May 17, 2013. REUTERS/Kai Pfaff …

By Eva Taylor

FRANKFURT (Reuters) - Europe's slow economic recovery and deflation fears have prompted Germany's Bundesbank to take a closer look at printing money, one of the most divisive tools the European Central Bank has in its arsenal.

Central banks in the United States, Japan and Britain have spent billions buying loans and sovereign bonds from banks to help revive their economies, a policy known as quantitative easing or QE.

The ECB has so far refrained from joining them, not least because of resistance from the powerful German central bank. Such asset purchases with new money would also be more difficult to undertake in a currency union of 18 member countries.

But Bundesbank President Jens Weidmann surprised markets on Tuesday by laying out in unusually open comments how QE could work in the euro zone and where the red lines would be, should the ECB ever have to take such a step to fight falling prices.

"Looking at the full comments by Weidmann this week, we acknowledge that the shift in tone is significant, but at the same time it is hard to conclude that the Bundesbank is willing to push hard for Fed-style QE either," said Frederik Ducrozet, senior economist at Credit Agricole CIB.

The Bundesbank has been a stern opponent of the ECB's government bond purchase programmes, drawn up during the debt crisis, saying they pushed it too far into the realm of financing governments, something it is banned from doing.

German weekly magazine Der Spiegel portrayed the Bundesbank chief earlier this year as "Mr. No".

Now Weidmann has conceded that the impact of any further cut in interest rates that are already near zero would be limited and that a discussion is needed about non-conventional measures. Quantitative easing, he said, was not "out of the question" despite a number of possible legal hurdles.

Buying assets to fight deflation is different, especially if private assets are bought, Weidmann said, making it clear that his reservations about monetary financing persisted.

The ECB spent 100 billion euros on covered bonds between 2009 and 2012, which the Bundesbank did not oppose.

The Bundesbank is mainly planning for the possibility that inflation slows further.

As the economy continues to stutter, euro zone inflation has now been in what ECB President Mario Draghi has called the "danger zone" below 1 percent for five months.

The ECB expects inflation to rise and moving closer to its target of just below 2 percent over the next couple of years.

But if the euro exchange rate continues to strengthen, making prices for imported goods cheaper and thereby driving inflation even lower, the ECB might have to take drastic action.

On Wednesday, Bundesbank board member Andreas Dombret played down the risk of deflation in Europe. "Fears of a fate similar to that of Japan are ... misplaced," he said in New York.

Others are less optimistic.


Weidmann's remarks came as other central bankers, including Finland's Erkki Liikanen, talked up the option of ECB action.

And while some economists said the Bundesbank president "left the door open, although only slightly" for asset purchases, others saw it merely as a more precise statement of its position and an attempt to talk down the euro exchange rate.

The euro hit a three-week low after the Weidmann interview in which he also said his preferred tool to temper the currency would be a negative deposit rate - which would mean charging banks to park their funds at the ECB overnight.

"It does not mean that negative deposit rates are 'around the corner'," UBS economist Reinhard Cluse said. "Rather, it suggests that the ECB is making more of an effort now to manage the euro lower."

Several other ECB policymakers, including Draghi, have tried to talk the euro down in recent weeks. The currency has edged closer to $1.40 after the ECB disappointed markets at its March meeting by holding rates and not deploying any other measures.

The ECB will meet again next week and it remains to be seen if talk will be enough to keep the euro zone recovery on track.

The real proof of Weidmann's message will show in the ECB's response if euro zone inflation slips further below its target.

(Additional reporting by John O'Donnell and Andreas Framke; Editing by Catherine Evans)

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