By David Barwick

MADRID (MNI) – The monetary policy stance of the European Central
Bank is appropriate for the current circumstances, which include a tame
inflation outlook, ECB Governing Council member Nout Wellink told Market
News International.

The head of the Dutch National Bank said in an interview conducted
Friday on the margins of the Informal Ecofin here that while the
prospects for price stability are still tinged by uncertainty, mainly
with regard to commodities, the continued fragility of Europe’s economic
recovery has left unchanged policymakers’ assessment that inflation
pressures will remain subdued.

The recovery from the crisis is underway and will continue, albeit
at low GDP growth rates of about 1.5% at most, Wellink said. If 1Q turns
out to be weak, a possible result of unfavorable weather, that does not
necessarily imply that the upward trend in economic activity is no
longer intact, he said.

Wellink said he was pleased with the way the ECB’s withdrawal of
non-conventional liquidity measures has been proceeding and that he saw
no reason at the moment to expand the covered bond purchase program.

“Monetary policy is appropriate at this very moment and the
perspectives for price stability are good,” he said. The “little bit of
a surprise” in last month’s Eurozone HICP reflected the uncertainty in
energy prices, “always an uncertain element,” he said.

“Depending on commodity price developments especially, there might
be — or there is — the possibility of upward pressure,” he said. “But
even including that, it’s still moderate.”

Wellink’s relatively relaxed view of the inflation outlook is
consistent with most Council members’ pronouncements. Even though the
Eurozone HICP rate jumped unexpectedly in March to a 15-month high of
1.4% y/y (revised down from an initial estimate of 1.5%), ECB President
Jean-Claude Trichet downplayed it in his April 8 press conference as the
result of unusually cold weather and volatile energy prices.

However, the ECB’s chief economist Juergen Stark last week
surprised markets by issuing a strong inflation warning. Strong growth
in developing countries, he said, could put upward pressure on commodity
prices, leading to higher inflation rates in Europe before the economy
has reached a stable path of growth.

“This could mean stagflation,” Stark cautioned.

And, putting monetary policy back on the map for the first time in
many months, he added: “It is dangerous to hold on to low interest rates
for too long. We must and will act at the right time.”

But Wellink made clear that in his view the inflation impulses
coming from emerging market economies are not yet sufficient for a
change of assessment. “I know China is doing quite well, but our
economies are still fragile and we get mixed signals,” he said. “One
month certain indicators are really going in the right direction, and
then the next month confidence falls back.”

He continued: “So what follows from that is that the situation
hasn’t changed and our appreciation of what’s in front of us hasn’t
changed during the last few months.”

Wellink predicted that the recovery in Europe is likely to remain
modest, producing “rather low” growth rates of “at most some 1.5% or
so.” He added that, “these figures, if they are the right figures, will
not put firm additional pressure on prices.”

He reiterated that “the uncertainty is in the commodity markets.”
But Europe in the recent past has shown it “could cope with a surge in
oil prices…and still control inflation,” he argued. “So as far as
inflation is concerned, I think it’s okay.”

Asked if an exacerbation of inflation risks would pose a dilemma
for the ECB given the other factors currently arguing against monetary
tightening, Wellink said it was still “much too early to speculate.”

In the short term, despite some positive indicators, “rather bad”
weather could leave a mark on 1Q activity, he said, citing central bank
calculations that suggest a severe winter could shave between a quarter
and half a percentage point off GDP growth in a given quarter.

“The building sector especially has been hit hard,” he noted. “And
if the first quarter shows disappointing figures, I think one should not
conclude from that that the underlying trend is not continuing in the
right direction.”

Indeed, Eurostat reported Monday that construction activity in the
Eurozone dropped 3.3% m/m in February, its sharpest drop in 14 months —
due largely to harsh winter weather. The Bundesbank said in its monthly
bulletin that Germany’s economy would likely contract slightly in the
first quarter because of bad weather – though it is expected to bounce
back in 2Q.

Although Europe appears to be recovering more slowly than other
regions of the globe, it doesn’t necessarily mean that will continue to
be the case over the longer term, Wellink said. “Perhaps European
developments over time are more stable,” he suggested.

That said, Europe also faces longer-term uncertainties that must be
addressed, he observed, citing in particular the red ink of Europe’s
national governments. “We have to reduce our budget deficits, that’s
quite clear, otherwise we are going to crowd out the private sector,” he
warned.

Moreover, “the banking system is still recovering, and we need a
banking system that can fulfill its intermediation [function]
adequately,” he said. In some countries there is also “uncertainty about
the extent to which the banking system will recover quickly enough to
fulfill that function.”

Wellink noted that an additional burden for the recovery is
unemployment, which is expected to continue mounting. “The implication
being that consumption may go up, but not become very buoyant,” he said.

So despite the positive impulses from exports, which “are doing
quite well” as other parts of the world emerge from the slump, “only
later on, if consumption is picking up, do you get a more balanced
overall growth picture and therefore a stronger growth picture,” he
said.

With regard to the euro, Wellink said that despite some evident
correlation between certain events in Greece and movements in the euro’s
exchange rate, he “would be very hesitant in drawing directly firm
conclusions between what’s happening in Greece and the level of the
euro.”

“There are other factors that play an important role,” he
explained. “One of these factors is that the American economy came back
on track at an earlier moment than the European economy and the
Americans started with their exit policies also at an earlier moment.”

In any event, “the euro is still strong vis-a-vis other currencies
at the moment, compared to the past,” Wellink said, though “I’m not
saying overvalued.”

Wellink said he was “happy with the way things are going at the
moment” with regard to the withdrawal of non-standard liquidity
measures. He said it was a “a good thing” that the need to start
gradually unwinding he measures has been accepted by markets and “is not
a controversial issue.”

For now there is no apparent reason for the ECB to expand its
covered bond purchase program beyond the announced scope of E60 billion,
he said. “But as I said, that is for the time being and let’s reflect
and come back to this issue when we have completed the program.”

–Frankfurt bureau tel.: +49-69 720142. Email: dbarwick@marketnews.com

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