Luxembourg, April 16 (Bloomberg) -- European Central Bank council member Yves Mersch said the bank may consider easing its inflation limit following criticism that it has been too slow to cut interest rates. The ECB, which sets monetary policy for the 12 states sharing the euro, has failed to keep inflation from exceeding 2 percent in every month but five since the start of 2001. Allowing inflation to exceed its limit for certain periods may make it easier for the ECB to cut rates and boost a struggling economy. ``It is a question whether there ought to be symmetry'' in allowing for upward or downward deviations from the inflation limit, said Mersch in an interview. ``I would not be surprised if this would be one element of the discussion'' before the ECB concludes its first strategy review since its inception in 1998.
The ECB has cut rates six times since the start of 2001, half as often as the U.S. Federal Reserve, and drawn criticism from politicians, including German Chancellor Gerhard Schroeder, and companies such as Siemens AG for acting too slowly. The euro region's $7 trillion economy, second only to the U.S., last year expanded at its slowest rate in almost a decade. The European Commission this month said the economy may have contracted in the first quarter. Unlike the U.S. Fed, which must try to achieve a maximum amount of employment as well as stable prices, the ECB's primary task is to combat increasing prices.
`More Flexibility'
Accepting higher inflation ``would give the ECB more flexibility -- it would certainly accelerate ECB decisions,'' said Dieter Wermuth, an economist at UFJ Bank Ltd. and a former aide at the German government's panel of economic advisers. Wermuth said the ECB may allow inflation rates of between 1.25 percent and 2.75 percent. European inflation remained at an 11-month high of 2.4 percent in March. Every ECB rate cut over the past two years was announced during months when inflation exceeded 2 percent because of rising oil prices or a weaker euro, indicating that the bank already accepts inflation rates that deviate from its ceiling. The ECB justified each rate reduction by saying that it expected inflation to fall below 2 percent in the following months. ``It's not a question of relaxing'' the ECB's 2 percent inflation limit, Mersch said, speaking at the central bank in Luxembourg, which he heads. ``It's a question of how well did it serve us? How well were we able to communicate it?''
No Targeting
ECB Chief Economist Otmar Issing said in March that central banks may have to accept inflation rates that deviate from their own limits during times of financial ``strain.'' The ECB has cut rates twice since December amid concern that the war in Iraq may hurt growth and destabilize financial markets. Central banks differ on definitions of acceptable inflation rates. The Bank of England has an inflation target of a 2.5 percent annual increase in retail prices minus mortgage interest payments. The central banks of South Korea, Australia and New Zealand seek to keep inflation within a specific range. Mersch said he is opposed to the ECB adopting inflation targeting, where central banks use monetary policy to achieve a specific inflation rate. The ECB may announce details of its strategy review, which is currently being conducted on a committee level, by the end of May, President Wim Duisenberg said earlier this month. The ECB has said the review won't necessarily lead to any changes in its monetary strategy.
Slowing Inflation
Mersch said slowing inflation in coming months may not prompt the ECB to cut rates, dismissing suggestions by the European Commission and the International Monetary Fund. A drop in inflation this year ``is not an argument in itself to again lower rates,'' according to Mersch. ``It is only vindicating our move of March 6,'' when the bank last pared borrowing costs. The ECB's benchmark lending rate currently stands at 2.50 percent, the lowest since October 1999. A further cut would take borrowing costs to the lowest for any country in the region since at least 1948. Investors are scaling back expectations for more rate cuts, interest-rate futures contracts show. The rate on a three-month euro deposit maturing in June has risen to 2.49 percent from 2.31 percent at the start of April. The three-month money market rate is at 2.56 percent.
Fighting Deflation
The ECB may also move to ease concern about possible deflation in some countries, Mersch said. Bundesbank Chief Economist Hermann Remsperger said last week that the ECB shouldn't allow inflation in the region to slow below 1 percent, just as price appreciation in Germany approaches that level. Inflation in Germany slowed to 1.2 percent in March. ``We said we would not accept deflationary tendencies -- maybe it was not said explicitly enough,'' said Mersch. The ECB never said it aims to keep inflation between ``zero percent and two percent,'' according to Mersch. Mersch suggested the ECB has no plans to diminish the role of M3 money supply growth in its strategy, even after the bank's gauge of future inflation exceeded its 4.5 percent reference value for the past 21 months. Money supply growth ``is still of high value in our strategy,'' said Mersch at the headquarters of the Luxembourg central bank. Price appreciation figures alone ``might not give early warnings of pressure building up that may unwind suddenly and become a threat to inflation later on.'' //www.bloomberg.com