ECB needs to be more flexible as it chases inflation: Knot

September 14, 2016 6:31 AM EDT

The headquarters of the European Central Bank (ECB) are pictured in Frankfurt, Germany September 8, 2016. REUTERS/Ralph Orlowski/File Photo


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VIENNA (Reuters) - The European Central Bank needs to be more flexible in interpreting its inflation mandate, Governing Council member Klaas Knot said, the second rate-setter in two days to urge caution as the bank prepares to review its policy stance.

Speaking in Vienna on Wednesday, Knot argued the ECB is trying to overcome the biggest economic shock in 80 years, and even more stimulus could diminish returns and amplify negative side effects.

Knot's comments come hours after Executive Board member Sabine Lautenschlaeger said existing measures should be given more time to work and there was no need now to change the bank's policy stance.

Though both Lautenschlaeger and Knot are considered hawks who have sided with the minority in the past to oppose some measures, their criticism may temper market expectations for more stimulus.

With inflation running below the ECB's target for more than three years, President Mario Draghi said the bank would study options to ensure the smooth implementation of its policies and its working committees would have a full mandate to explore options.

"There is a pretty clear case to be made that the medium term should be interpreted flexibly," said Knot, the Dutch central bank chief, about the ECB's inflation target.

Knot added that a key challenge for the ECB is the disconnect between its communication and market expectations, a potential danger if the bank becomes a captive of market expectations.

"You see a lot of speculation about what's next. I think it's very dangerous for a central bank to become too much captive of financial market expectations," he said.

The ECB's 80 billion euros per month asset buys, intended to cut lower borrowing costs and accelerate growth, are set to run out in March and markets fully price in a six-month extension of the scheme by the ECB's December meeting.

"If we need to find instruments, we will find instruments," Knot said." One should never underestimate the degree of innovation that also takes place within central banks."

"The problem is of course one of decreasing returns to scale... ff you provide more and more of essentially the same medicine," Knot added. "So you have decreasing efficiency and probably increasing side effects."

(Reporting by Francesco Canepa; Writing by Balazs Koranyi; Editing by Jeremy Gaunt and Andrew Heavens)



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