BANK OF FINLAND
Press release number 10
15 Mar 2012

Governor Erkki Liikanen: Long-term refinancing operations pose no threat to price stability

The debt crisis in the euro area deepened once again in autumn 2011. This increased uncertainty in the economy and significantly hampered the functioning of the financial markets. The impacts on financing conditions and on household and business confidence were, as expected, negative. There was a rapid deceleration in the pace of global economic growth, and in Europe the economy contracted.

The economic policy decisions of December 2011 were necessary in order to break the negative spiral and restore confidence. Future developments, too, will depend as much on political decisions and their implementation as on economic determinants. ‘Slippages in the implementation of political decisions in the current fragile economic and market situation would be dangerous and costly,’ affirmed Bank of Finland Governor Erkki Liikanen at the press briefing for the release of the latest issue of the journal Euro & talous.

‘The Eurosystem’s two 3-year refinancing operations have had a decisive impact on market developments,’ Governor Liikanen continued. These refinancing operations of exceptionally long duration and unprecedentedly large scale calmed the worst fears of the markets and began to narrow risk premia that had recently grown very large. In practice, these long-term refinancing operations will cover the liquidity needs of the banking system for three years ahead, providing support for bank lending and financial intermediation throughout the euro area.

‘Central bank measures can be used to calm the financial markets, but a permanent solution to the debt crisis will require both successful fiscal and structural policies and a controlled and timely exit from the temporary central bank measures,’ said Governor Liikanen.

The Bank of Finland forecasts that global economic growth in 2012 will be very sluggish, at just over 3%. Towards the end of the forecast period, however, the global economy and world trade will return to the average pace of growth witnessed in the years 2003–2010. This forecast is based on the assumption that it will be possible to implement policy measures sufficient to bringing the crisis under control and permanently resolve the debt crisis.

The growth risks to the forecast are predominantly on the downside. Economic history has shown that recovery from a financial crisis is a slow and uneven process. The positive spiral could be cut abruptly if, for example, there were to emerge gaps between the aims and concrete achievements of stabilisation policies. The inflation risks to the forecast at the global level are currently moderate and relate primarily to fluctuations in world market prices for energy products. The most significant positive risk relates to the forecast trend in the US economy.

At its March meeting, the Governing Council of the ECB decided to leave its monetary policy stance unchanged. It did, however, lower its growth forecast and raise its short term inflation forecast. ‘Euro area inflation will continue above 2% in 2012. Over the policy-relevant medium term, inflation risks remain balanced and inflation expectations firmly anchored,’ affirmed Governor Liikanen.

Short-term market interest rates have come down strongly in recent months. The widespread use in Finland of short market rates as loan reference rates means that the loan interest paid by households and businesses is also clearly falling. Monetary policy transmission in Finland is among the most rapid in the euro area, while growth in the stock of household and corporate loans is well above than the euro area average. ‘In Finland, a decline in short market rates as a consequence of monetary policy feeds through quickly into the interest paid on loans. When making a decision to borrow, it is important to understand that the current exceptionally low interest rates cannot be relied upon to last for decades ahead,’ Governor Liikanen emphasised.