–Adds Comments on Exit Strategy, Portugal, EMS, China

PARIS (MNI) – Negative real short-term interest rates in the
Eurozone favor excessive risk-taking and market distortions, European
Central Bank Executive Board member Lorenzo Bini Smaghi warned in an
interview released Wednesday.

“For the moment, there are no second-round effects and inflation is
mainly imported,” Bini Smaghi told the French daily Le Monde. “But
interest rates are now lower than inflation, which could have been
justified in a scenario of deflation risks.”

“Even though the moderate economic recovery we expect in the
Eurozone is shrouded by uncertainty, we are no longer in a scenario of
deflation risks,” he said. “We must take this into account when we
decide on the level of interest rates.”

“Maintaining rates so low makes monetary policy very expansionary,
at the risk of creating distortions on the markets and inciting
financial institutions to take excessive risks,” he said.

Asked whether hiking rates in April would not be repeating the kind
of mistake the ECB made by tightening monetary policy in the summer of
2008, Bini Smaghi argued that a better comparison would be with 2005.

“At that time, the ECB had begun to hike rates after a long pause,”
he reminded. “Our action was highly criticized at the time by economists
who thought we were too far ahead of the curve. Ex post, they recognized
that we were right and some even chided us for waiting too long.”

Concerning the risks of a hike for countries already in
difficulties, Bini Smaghi noted that the ECB still provides loans of
unlimited amounts for banks.

“The situation makes it more difficult to unwind the exceptional
mechanisms for the ECB’s financing of banks,” he conceded. “We are
studying ways to create incentives for banks that are not dependent to
free themselves of the ECB’s unlimited financing.”

The central banker said it was up to Portugal itself to decide
whether or not to seek financial support to restore the confidence of
markets. Either way, “the budgetary and structural measures will be the
same,” he said.

The ECB’s actions cannot substitute for the responsibility of
governments to recapitalize banks, reduce deficits, bolster growth or
improve labor markets, he insisted, criticizing the lack automatic
sanctions against deficit offenders and the unanimous accord required
for access to the future bailout fund ESM.

“Countries should have less freedom to issue debt,” he said, noting
his own proposal for an independent European financing agency with
powers to limit debt issuance.

Bini Smaghi expressed concern about rising inflation in the
emerging economies, which are the locomotives of global growth: “Their
growth must not be impaired due to uncontrolled inflation.”

“Countries like China, where inflation is rising, should not
hesitate to raise their interest rates and let their currencies
appreciate, which would help rebalance global growth,” he said.

–Paris Newsroom, +331 4271 5540; stephen@marketnews.com

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