Banks must not always bow to markets, warns top ECB official

“TREMENDOUS” debt levels pose a major challenge to the eurozone and its economic policymakers, top European Central Bank official Ewald Nowotny warned in his last week on the governing council.

In the past, he said, wars and bouts of severe inflation have cleared out these debts, but that has not happened in recent history, leaving the continent with an unprecedented economic challenge.

“The fortune of a now 74-year peace period has inevitably led to the problem of a tremendous accumulation of wealth on one side and debts on the other,” he told the Austrian newspaper Wiener Zeitung.

“That is undeniable. In the past, wars or high inflation virtually eliminated this problem. How we solve this without these two factors is still open.”

He also hinted that the central banks should stop following market expectations, potentially refusing to cut rates or ramp up quantitative easing even when investors anticipate more support from looser monetary policy.

“Over the past few years we have perhaps followed the expectations of the markets too much and have avoided disappointing them. I believe that central banks should be the crucial institution, and that sometimes they must disappoint markets.”

Meanwhile Christine Lagarde, the incoming president of the ECB, raised the possibility of more easing.

“The ECB’S non-standard monetary policy measures have provided substantial support to the euro area economy. These measures have thus far proved to be powerful, and can be extended and adjusted depending on the needs,” she said, in response to written questions from members of the European Parliament.

The former head of the International Monetary Fund added that reforms are needed to the structure of the eurozone, and that governments must stick to the borrowing rules – a key demand given that Italy has had run-ins with Brussels over its deficits.

“Compliance with the fiscal rules is necessary to ensure sustainable public finances at the member state level which are a prerequisite for a smooth functioning of EMU [the Economic and Monetary Union],” she said.

“Moreover, adherence to the Stability and Growth Pact should support the build-up of fiscal space in good times which can then be used to provide stabilisation in bad times.”

At the same time Klaas Knot, another ECB policymaker, said the current economic position does not require more QE to stimulate growth and reassure markets.