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ECB excess liquidity policy should not become permanent - Mersch

FRANKFURT (Reuters) - The European Central Bank's scope of action is limited and its policy of providing banks with more liquidity than they need should not become a permanent feature, ECB Executive Board member Yves Mersch said on Tuesday.

The comments from Mersch, a hawkish member of the ECB's Governing Council, came after other policymakers said last week they were open to taking fresh measures to support the euro zone economy, where inflation is running well below target.

A new batch of long-term loans, or LTROS, to inject liquidity into the financial system is widely seen as one policy option for the ECB, although another hawk, Jens Weidmann, said last week the bank must ensure its lending operations do not become too generous.

Mersch said the ECB should ensure its liquidity flows smoothly to the banking sector.

"Excess liquidity policy, however useful and necessary it has been - and still is, should not become a permanent feature," he added in the text of a speech entitled 'Economic and Legal Limits of Central Banking", for delivery at a conference at the Goethe University Frankfurt.

"It should be limited in time to avoid dressing-up non-performing loans or ever-greening bad assets that would undermine incentives to restructure or to address structural weaknesses in banks' balance sheets," he said.

The ECB used twin long-term liquidity operations, or LTROs, to funnel banks over one trillion euros $1.35 trillion (834 billion pounds) in 3-year loans in late 2011 and early 2012 - a move ECB President Mario subsequently said "avoided a major, major credit crunch".

The ploy boosted excess liquidity, the amount of money in the market beyond what banks need for their day-to-day operations, though this has now fallen back to its lowest level since September 2011 as banks repay the LTROs early.

Another policy measure some ECB policymakers have mentioned as a possibility is quantitative easing (QE), or asset purchases. Without mentioning QE, Mersch stressed that the ECB could not buy government bonds on the primary market.

"The ECB was assigned a precise mandate: to maintain price stability," he said. "The scope of action is limited and some tasks are explicitly prohibited, e.g. the outright purchases of government bonds on the primary market, i.e. the monetization of public debt."

(Reporting by Sakari Suoninen; Writing by Paul Carrel Editing by Jeremy Gaunt)