The European Central Bank has not "tied itself to the mast" with its use of forward guidance on low interest rates, and could raise them if inflationary pressures emerge, ECB policymaker Jens Weidmann said on Thursday.
Abandoning its traditional policy of never pre-committing on future rates, the ECB said a week ago it would keep its interest rates at present or lower levels for an "extended period," its first use of so-called forward guidance.
The ECB took the unprecedented step in response to market volatility, which set in after the U.S. Federal Reserve last month set out a plan to begin slowing its stimulus. New comments from Fed chief Ben Bernanke sparked more turmoil on Thursday.
Uncertain about when the Fed will wind up its stimulus, markets are trying to assess how long the "extended period" of low ECB rates could last, a task made harder by the varying tones to comments from ECB policymakers over the last week.
Weidmann, a staunch defender of the ECB's mandate to contain inflation, stressed that the ECB's monetary policy stance was conditional on economic developments.
"It is not an absolute advanced commitment of the interest rate path," he said in a speech in Munich. "The ECB Council has not, like Odysseus, simply tied itself to the mast."
While the ECB's expectation for rates to remain low was justified by a weak economic environment, Weidmann said the ECB's policy move last week "is not a historic change in monetary policy communication".
Rather, it was simply an effort to give more guidance in a time of high uncertainty, said Weidmann, whose position as the central bank chief in the euro zone's biggest economy gives him a strong voice on the ECB's 23-man Governing Council even if he theoretically has the same power as other members.
Low rates "are not without side effects", he added.
"Even if these are justified for monetary policy, we may not close our eyes to them: they can lead to reforms and necessary structural changes being deferred. Financial stability risks can grow," he said. "These side effects increase with time."
Another ECB policymaker, Benoit Coeure, who said on Wednesday the ECB would be "ready to react flexibly," echoed Weidmann on Thursday and said the low rates should not lull governments into thinking they have longer to implement reforms.
Another ECB policymaker, Joerg Asmussen, said on Tuesday the "extended period" of forward guidance meant "not six months, it's not 12, it goes beyond."
But the ECB promptly issued a statement saying Asmussen had not intended to give any guidance on the exact length of time for which it expects to keep rates at record lows.
While Weidmann stressed the risks attached to low rates, the ECB struck a different tone in its monthly bulletin on Thursday, saying the scope for interest rate cuts had not been exhausted.
"The key ECB interest rates can be reduced further if warranted by the evolving outlook for price stability," it said.
The ECB also offered a little clarity on the duration of the forward guidance, saying it was consistent with, but not directly linked to, its decision in May to extend the full allotment liquidity policy until July 2014.
"The extended period of time over which the Governing Council currently expects the key ECB interest rates to remain at present or lower levels is a flexible horizon which does not pre-specify an end-date," it added in the bulletin.
The low rates were conditional on the Governing Council's assessment of the economic fundamentals that determine underlying inflation. Giving some detail on the conditions for low rates, the ECB added:
"A scenario of subdued inflation will continue to warrant keeping the key ECB interest rates at very low levels for as long as broad-based subdued trends in aggregate demand and persistently weak monetary and credit trends prevail."
The ECB also expressed satisfaction at the market reaction to its guidance move, saying that "after the Governing Council's communication on 4 July the forward rates based on overnight index swaps have declined appreciably."
But fresh comments from Bernanke late on Wednesday on the Fed's monetary policy highlighted the sensitivity of markets to the timing of measures from the big central banks.
Shares and bonds rallied globally on Thursday and the dollar tumbled, after the Federal Reserve chairman signaled the U.S. central bank may not be as close to winding down its stimulus program as markets had started to believe.
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