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Bundesbank unfazed by emerging markets, Nowotny cool on rates

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[February 18, 2014]  By Eva Taylor and Francesco Canepa

FRANKFURT / LONDON (Reuters)  The turbulence experienced in emerging markets early this year is insufficient to derail a recovery in the global economy, which could strengthen during 2014, Germany's Bundesbank said on Monday.

Currencies in Turkey, South Africa, Hungary and Russia suffered major sell-offs over the past month before recovering slightly after central banks fought back via interest rate hikes or exchange rate interventions.

With euro zone inflation far below the European Central Bank's target, policymakers in Frankfurt, including Bundesbankers, are watching the turmoil in case it affects the economic outlook.

The ECB says the bloc has proved resilient so far.

Speaking in London, ECB Governing Council Ewald Nowotny said it was "good news that we see improvements in the real economy" but added that the central bank still needed to discuss how this affected inflation.

Slightly stronger-than-expected growth in Germany and France pushed the euro zone's recovery up a gear in the fourth quarter.

The ECB has set out two scenarios that could trigger fresh policy action: a deterioration in the medium-term inflation outlook and an "unwarranted" tightening of short-term money markets.

"There might be good arguments to say let's wait and see (on interest rates)," Nowotny said, adding: "A negative deposit rate ... is one potential element but there has been no decision and we are still in the process of discussion."

Negative rates essentially entail charging banks to hold their money, thus encouraging them to lend.

A cut in interest rates is just one option for dealing with low euro zone inflation  running at 0.7 percent and below the ECB's target of just under 2 percent  or tight money markets.

Another option the ECB has discussed is to suspend operations to soak up money it spent buying sovereign bonds during the euro zone's debt crisis under its now-terminated Securities Markets Program (SMP).

The Bundesbank signaled that, to help stabilize euro zone money markets, it would be open to adjustments of the ECB's weekly withdrawal of money it spent on the SMP.

"Overall, the Bundesbank therefore is open to a possible adjustment of the hitherto offer of liquidity absorbing operations, should this be suited to stabilizing money markets and liquidity conditions and thereby signal even more clearly than so far the accommodative monetary policy stance of the Eurosystem," it said.

Such a step would add about 175.5 billion euros ($240.19 billion) to the market.

ECB Executive Board member Benoit Coeure, asked by Reuters about the idea last week, said such options can be effective, adding: "But I don't see the need to do it now."

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In its February monthly report, the Bundesbank said China appeared poised to continue growing without much disruption but noted that central banks in some emerging economies had hiked rates in response to capital outflows and currency falls.

"Even if this should slow the economic growth of the countries concerned, their low global weight means it is not to be expected that the recovery of the world economy will be appreciably affected," the German central bank added.

In Germany, the underlying economic momentum should have "increased appreciably" in the final quarter of 2013 and the first of 2014, it said, noting "almost continual improvement" in companies' and households' assessment of the situation.

"However, this should only fully show up in the GDP growth rates at the turn of the year, when the increased order inflow translates into production," the Bundesbank added.

The German economy grew by 0.4 percent in the final quarter of last year.

"In the euro zone, if burdens from the debt crisis still exist, the signs are increasing for a gradual economic recovery," the bank said.

The Bundesbank noted that increased risk aversion in financial markets led early this year to a fall in share prices and a flight into liquid government bonds, adding:

"Nevertheless, the valuation level of shares on both sides of the Atlantic is still relatively high."

In a section of its report on the German property market, the Bundesbank said residential prices continued to rise, with prices in 125 German cities up 6.25 percent in 2013, though it still saw no larger macroeconomic risks in the market overall.

"There is currently no indication for a destabilizing interaction between real estate price increases and credit supply on a macroeconomic level," the Bundesbank said.

Prices rose significantly more strongly in cities than in rural Germany. The Bundesbank said residential property in big German cities was probably over-valued by 25 percent on average.

($1 = 0.7307 euros)

(Writing by Paul Carrel; editing by Jeremy Gaunt)

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