No Risk to Inflation; No Floor Under 1% Rate: ECB Official

Inflation expectations for the medium and long term are anchored, and there never was a floor under the European Central Bank's 1 percent interest rate, ECB council member Erkki Liikanen told CNBC in an interview.

The ECB will always focus on price stability as it is its sole mandate, but right now there is no "particular concern" when it comes to inflation expectations, he said.

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"There's not been upside risk at the moment [for inflation]," Liikanen said.

Some analysts have said that there was a floor under the record low 1 percent interest rate and that the central bank will not want to push rates any lower.

"We have never said so… that there’s a floor. I’m sure that we will never say so. There are no tactical obstacles to go further but everything of course depends on the analysis of the economics side and monetary and credit side. On the other hand of course, the closer you go to zero your margin starts to get limited. That’s pure common sense," Liikanen said.

The Bank of Finland governor said that markets had been mispricing risk in the euro zone in the first years since the European Monetary Union was created, and that spreads between bonds of various countries in the area will never be as narrow as before the crisis.

"When the European Monetary Union was created it was a big surprise for me that the spreads disappeared in all the countries, and the countries never changed overnight," Liikanen said.

"Perhaps in historical terms that narrowing was overblown. Maybe that in the future one may say that this widening … the reaction also was excessive," he said, referring to the current crisis.

"The euro is, will remain a firm anchor in the European economy and the ECB will play its role in that process."
Erkki Liikanen
ECB Governing Council member"I wouldn't expect that we'll see in the foreseeable future, if ever, such narrow spreads among the euro area countries. Markets will assess the performance of each country on its own merit," Liikanen added.

Spreads Narrowing

Spreads between the yields of Spanish 10-year bonds and German Bunds, for example, are currently above 315 basis points and they hit a record above 420 basis points last November when fears of the euro zone debt crisis spreading were at their height.

Italian bond yield spreads versus Bunds were over 430 basis points in November and are currently hovering above 360 basis points.

Spreads are expected to narrow further as Greece's parliament approved a debt-swap agreement with its private creditors under which bondholders will take real losses of more than 70 percent on their holdings.

For Greece it will be crucial that the reforms agreed under the terms of its second bailout are implemented on time, Liikanen said.

"The country needs to keep moving, it has to deliver every time and sooner or later it will pay off. But it's not easy, we know. It's also painful, but there are countries who have done it. And now the decision creates much better circumstances for delivery," he said.

The narrowing of spreads on sovereign bonds, as well as the narrowing of spreads between unsecured and secured lending were signs that the economy was stabilizing somewhat but "still uncertainty is high," he said.

The European Commission on Thursday cut its forecasts for the euro zone's economy, predicting that it will shrink this year rather than grow slightly as it had estimated previously.

The policymakers must focus more on the imbalances within each country, as they did not pay enough attention to the differences of competitiveness within the euro area, according to Liikanen.

"It's important, within the euro area, that every country also performs in a way that it doesn't create excessive risks for the whole euro area and to the economic region," he said.

Markets and Rules

Over-regulating limits the growth potential so policymakers will have to look both at public finances and at the economy, the ECB governing council member said.

"You must have proper fiscal rules and you must have programs that release the economic potential of the country."

Some observers say the EU's credibility has been dented by its inability to impose strict fiscal discipline in the past on its biggest members, with both France and Germany breaching the EU's rule of a public deficit no higher than 3 percent of gross domestic product in the past.

But this time it will be easier to implement the EU's strict fiscal discipline because not only are the rules tougher but markets are policing their implementation, he said.

"After this crisis, for one generation, it will be different because we have our own memories," he said. "If you have both – markets and the rules – you have two who control."

European banks' profits were hit by writedowns on their Greek debt and also by the ongoing crisis, with Commerzbank's earnings affected while Dexia and Credit Agricole took a hit as well.

But Liikanen said he had reasons for optimism for European banks as the European Banking Authority (EBA) had said that banks had solid plans to boost their balance sheets.

"Now it seems that most banks are able to do it, mainly do it by retaining profits… they are doing it without deleveraging, that is a good sign," he said, pointing out that in Europe the role of banks for funding companies is more important than in the UK and the U.S., where firms can go raise and cash directly from the markets.

Suggestions that the euro zone will break up have become more numerous as the crisis persisted, but Liikanen dismissed them.

"The euro is, will remain a firm anchor in the European economy and the ECB will play its role in that process," he said.

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