UPDATE 1-Mersch says QE would pose immense challenges for ECB

Mon Dec 9, 2013 2:48pm IST

* ECB statute allows outright buys of govt, private debt

* Buying private debt would shift risk to tax payers

* Negative deposit rate could raise borrowing costs (Adds more detail on policy options)

FRANKFURT, Dec 9 (Reuters) - Buying government bonds or other assets outright in the market is possible for the European Central Bank, but poses immense challenges for the central bank, Executive Board member Yves Mersch said on Monday.

Mersch also said that central banks should not fall into the trap of trying to do too much, and warned that available tools also have negative side effects.

The ECB kept interest rates on hold last week and reiterated that it still had a powerful artillery of tools available should the euro zone economy need more stimulus.

Mersch said one the tools was quantitative easing, a measure the U.S. Federal Reserve and the Bank of England have made use of to revive their economies.

Buying sovereign debt in the secondary market was possible in the euro zone, Mersch said, but the lack of a central government whose debt the ECB could buy made this more difficult.

"To define portfolios of government bonds of euro zone member states and then to buy them would pose immense economic, legal and political challenges for the ECB," said Mersch.

The ECB could also buy private assets, but such a step would increase the risk exposure of the ECB's balance sheet, shifting private risk into the public domain, eventually burdening tax payers.

Another tool the ECB has it to cut the interest rate banks get for parking their deposits at the central bank overnight below the current level of zero, which means banks would have to start paying to do this.

A negative deposit rate could be an incentive for banks to channel excess funds into the real economy rather than having to pay to keep them save at the ECB.

But Mersch said the risk was that banks would pass on such higher costs on to customers, making loans more expensive.

Third option Mersch named was providing more long-term loans, but there was a danger that the money would be used mainly for buying government bonds.

Linking loans to a specific purpose would make the central bank make hard normative choices about purposes worthy of lending, he added.

There were other options, Mersch said, but none of them were about to be deployed. It would take time for the recent measures to gain traction and the ECB should aim to avoid inflationary or deflationary tendencies over the long term.

For now, there were no deflationary risks, Mersch said.

The ECB cut its main interest rate to a record low of 0.25 percent in November after a sharp fall in inflation, which has picked up since. (Reporting by Sakari Suoninen, writing by Eva Taylor; Editing by Toby Chopra)

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