ECB’s Mersch Warns Loose Policy Raises Risk of Market Drop

(Bloomberg) --

European Central Bank stimulus has contributed to “very elevated” asset prices that raise the prospect of a sudden market drop, Executive Board member Yves Mersch said, in a speech that also warned of the risks to the institution’s credibility.

“These unusual times call for heightened vigilance regarding the financial-stability consequences of our monetary-policy actions,” Mersch said at an event in his native Luxembourg. There is “no clean separation between the pursuit of monetary stability and that of financial stability in the medium term.”

After years of falling short of its inflation target despite pumping trillions of euros into the financial system, the ECB is starting a wide-ranging review of its strategies. It’ll look at issues such as why price growth remains so sluggish and the effectiveness of instruments such as negative interest rates and bond purchases.

The side effects of those policies are increasingly becoming visible -- a development the ECB has acknowledged in both words and action. In its Financial Stability Review late last year, it warned of potential future market corrections; with its two-tier system of remunerating deposits it’s trying to alleviate pressure on bank profitability.

In an answer to questions after the speech, Mersch said that lenders’ margins are improving, but they’re still at a low level because they didn’t keep production costs in line with volumes. Household savings have been more or less stable, but the ECB would react to unwanted behaviors.

While backing the need for “highly accommodative” policy just now, Mersch noted that surveys show a divergence between support for the euro and trust in the ECB, with faith in the central bank waning since the financial crisis. That can blunt the effectiveness of its measures, by damping inflation expectations, and threaten its autonomy.

“A prolonged loss of trust in the ECB risks undermining the broad public support that is necessary for central-bank independence,” he said. “This is of particular concern when the range of non-conventional measures brings monetary policy closer to the realm of fiscal policy and the institutional effects of these policies are becoming more pronounced.”

--With assistance from Carolynn Look.

To contact the reporters on this story: Paul Gordon in Frankfurt at pgordon6@bloomberg.net;Stephanie Bodoni in Luxembourg at sbodoni@bloomberg.net

To contact the editors responsible for this story: Paul Gordon at pgordon6@bloomberg.net, Jana Randow

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