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ECB policy seen effective, so only minor tweaks coming: ECB and central bank sources

By Balazs Koranyi

By Balazs Koranyi

FRANKFURT (Reuters) - Appetite is low for a big European Central Bank policy shift so any change is likely to be just an adjustment of the current asset buying scheme and not a big overhaul, conversations with six sources on or close to the Governing Council indicate.

The ECB is increasingly aware of the limits of quantitative easing and considers the program effective, suggesting that only fine tuning may be needed, said the policymakers, who asked not to be named.

Although the next policy meeting is still a month away and views can change, the conversations suggest a disconnect between the views of policymakers and markets, which were already pricing in some action this month, when the ECB did not even discuss changes.


"Markets are getting ahead of themselves, again, and forget that monetary policy doesn't follow markets," a Governing Council member said.

With inflation hovering either side of zero in recent years, the ECB has unleashed extraordinary stimulus to kickstart growth and push up consumer prices. But growth is still lukewarm, at best, raising the prospect that even more stimulus is needed.


Some sort of extension of the asset buys in necessary as they are set to end abruptly in March, so even tapering would extend it, adding some stimulus.

But a rate cut is not seriously considered, the inclusion of new assets is not preferred and abandoning the so-called capital key, which requires the ECB to buy assets in proportion to the size of euro zone economies, though under consideration, is not at the top of the list.

"What is the actual benefit from a rate cut? Who is going to consume or invest more because of 0.1 percent?" said another Governing Council member. "But the signal to banks would be quite damaging."

Indeed, French central bank chief Francois Villeroy de Galhau said on Friday that rates were close to the bottom as there were clearly limits to negative rates.

Still, ECB President Mario Draghi already said the bank was looking at options to keep its 1.74 trillion euro asset buying scheme running, suggesting that some measures are coming.

The ECB declined to comment for this story.

Markets are pricing in a six-month extension of the scheme, set to run out in March, with some expecting a more radical changes, like an increase in monthly purchases, or an expansion into bank bonds, stocks, or non performing loans.

One option the ECB could follow is to agree on technical changes in October that could give sufficient room for the program to continue, if the Council decides on the extension.

However, a decision on substantive elements, like the length of the program is unlikely to come before the December meeting, when fresh economic projections are made available, the policymakers said.

Latvian central bank chief Ilmars Rimsevics already said that such discussion should happen when new staff forecasts become available at the end of each quarter, or December, at the earliest.

"The program is facing some constraints and I think by the time we need to make a decision, the constraints should be out of the way," a third policymaker said. "But the debate about extending QE really is open."

The problem is that the ECB is running out of assets to buy in several countries, especially in Germany, where much of the yield curve is trading below the ECB's -0.4 percent deposit rate, a limit for purchases.

An option could be to apply the deposit rate constraint to the average of purchases in a certain jurisdiction, not to each issue. But completely eliminating the deposit rate floor could raise legal questions because the ECB would buy debt at a loss, which could be considered illegal monetary financing.

Increasing the limit for how much of a particular bond the ECB could buy is also a relatively easy option, the sources said.

The capital key would be one of the most contentious options and Bundesbank President Jens Weidmann has already come out in opposition.

"The capital key would raise some legal question that would need to be cleared first. Given the legal and political complications, it’s not my preferred option," another Governing Council member said. "But it's not off the agenda."

New asset types are also a difficulty for now.

"Each new asset type increases the risk profile. And it take a long time to prepare. From the decision to buy corporate debt to the first buys, it took 3 months," one of the sources said.

(Additional reporting by Francesco Canepa; editing by Mark John)