The European Central Bank should cut interest rates in October and focus its firepower on bailing out Italy and Spain, while allowing smaller euro zone strugglers to restructure their debts, Citi's chief economist Willem Buiter said on Thursday.
Speaking to Reuters Insider in Moscow, Buiter, a former Bank of England policymaker, said the ECB could undo the impact of launching its tightening cycle earlier this year, as long as it promptly eased its benchmark rate, now at 1.5 percent.
"As long as they are willing to walk down the hill again as swiftly as they walked up it I don't think any lasting damage was done," he said.
"They have to change course, and not just stop raising rates; they have to actually cut them," he said. "It would be a nice parting gift from Monsieur (Jean-Claude) Trichet in his last meeting in October if he were to provide the first cut."
The ECB was expected on Thursday to signal a change in policy direction after making two quarter-point hikes over the past five months, although most economists do not expect policy makers to ease before December.
Let Peripherals Restructure
Buiter said that the ECB should also direct its financial firepower at shielding Italy and Spain from the debt contagion sweeping the euro zone periphery, while allowing smaller states Greece, Ireland and Portugal to restructure.
"Spain and Italy, if mismanaged, would not be a European, it would be a global problem," Buiter cautioned. "First, both countries have to make more credible commitments than they have thus far, especially in the case of Italy, to engaging in further fiscal tightening and structural reform required to restore sustainability."
He also said that it would fall to the ECB, rather than the EFSF bailout fund, to act as the lender of last resort given funding needs of Italy and Spain that run into the hundreds of billions of euros each year.
Buiter also called for the ECB to reintroduce fixed-rate full allotment collateralized lending for banks at longer maturities for euro-zone banks since the inter-bank market was "dying."
"They've done up to one-year collateralized loans before on a full-allotment basis and this is time to do it again," he said.
© 2014 Thomson/Reuters. All rights reserved.