ECB policymakers say rates near bottom even if recovery is disappointing

September 23, 2016 4:28 AM EDT

Governor of the Bank of France Francois Villeroy de Galhau attend a news conference held at the close of the G20 Finance Ministers and Central Bank Governors meeting in Chengdu in Southwestern China's Sichuan province, Sunday, July 24, 2016. REUTERS/Ng

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FRANKFURT (Reuters) - European Central Bank interest rates are probably close to the bottom, even though the bank had hoped the euro zone economy would respond better to its stimulus measures, two top policymakers said on Friday.

With ECB rates now well into negative territory, the potential for detrimental side effects are increasing as they cut into banking profitability and raise the risk of asset bubbles and market distortions, the policymakers said.

"Nominal interest rates are now probably close to the low point, which doesn't imply they will rebound soon," French central bank chief Francois Villeroy de Galhau, told a conference in Frankfurt.

"Negative rates are a useful part of our toolkit, but there are clearly limits to them," said Villeroy, an ECB Governing Council member. "We know there is a lower bound, even if we don’t know exactly where it is: somewhere slightly below zero."

The ECB has unleashed extraordinary stimulus in recent years, cutting rates aggressively, giving banks super cheap loans and pumping over a trillion euros into the economy through assets purchases.

But growth is still lukewarm and inflation, the bank's chief target, is still barely above zero, well short of its target of close to but below 2 percent, with little hope of getting to its objective over the next two years.

"We all hoped that reaction of the economy would have been much quicker as a result of the expansionary monetary policy we have put in place," ECB Vice President Vitor Constancio told the same conference. "It is taking longer than anyone expected."

Still, Constancio stressed that the bank was aware of the risks associated with low rates, including financial market imbalances and a hit to profitability of banks, key agents that transmit the bulk of the ECB's policy measures.

While low rates could lead to excessive risk taking, especially in equities and real estate, there were no signs of general bubbles, even if some localized overvaluations can be observed, Villeroy added.

"In the short run, interest rates will stay low and the yield curve will remain rather flat," Villeroy said. "In the longer run, as inflation picks up, nominal rates should in all likelihood rise again, more strongly – or less slowly – than real rates."

(Reporting by Balazs Koranyi; Editing by Larry King)

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