In the lion's den, Draghi to defend ECB at Bundestag

BERLIN/FRANKFURT (Reuters) - European Central Bank President Mario Draghi faces a grilling on Wednesday from German lawmakers who say the ECB's super-loose monetary policy has damaged the 19-country currency bloc and fuelled the rise of the populist right.

After repeated clashes in recent years, conflict between the euro zone's central bank and its largest economy is at risk of flaring up again as the ECB contemplates even more stimulus in the face of vocal objections from the German establishment.

Draghi will address the Bundestag lower house of parliament's European Affairs committee behind closed doors from 1530 (1330 GMT) and speak to the public around 1700 (1500 GMT). He is due to meet German Chancellor Angela Merkel on Thursday.

Facing lacklustre growth and the threat of deflation, the ECB has cut interest rates deep into negative territory and bought more than a trillion euros' worth of government bonds so far to cut borrowing costs and revive spending by firms and households.

But many in traditionally prudent Germany argue that sub-zero rates upset financial stability, consume household savings, destabilise banks and reward financial mismanagement by euro zone governments.

Gunther Krichbaum, who heads the European affairs committee that invited Draghi to Berlin, told Reuters the Italian ECB chief should expect a frank discussion.

"We're parliamentarians, not diplomats. Of course there'll be critical questions, but Draghi can handle this," Krichbaum said, adding that lawmakers would ask him about the ECB's bond purchase programme and the health of Italy's banking sector.

"Of course, the ECB is independent. But with its current monetary policy, the ECB under Draghi is going quite actively to the limits of its mandate," he added.

The heart of the problem is that German households prefer uncomplicated savings products that now yield nothing, eating into the retirement prospects of millions and endangering hundreds if not thousands of small savings banks.

Political analysts argue that much of the recent German criticism may also be a way of deflecting attention from Merkel's increasingly unpopular refugee policy and the poor showing of her Christian Democrats (CDU) in regional elections.

With a national election just a year away, Merkel is facing growing discontent, even from her coalition ally, raising doubts over whether she can lead her conservatives to a fourth election victory in a row.

Hans Michelbach, a member of the Bavarian Christian Social Union, the CDU's sister party, said ECB policies were a "fatal signal" for efforts to emphasise fiscal stability.

"Draghi is making the euro zone into a debt liability union and the ECB into a 'bad bank' via its bond purchases," he told Rheinische Post newspaper.

SELF CRITICAL?

Speaking in Frankfurt ahead of the hearing on Wednesday, Draghi struck a somewhat conciliatory tone but maintained that Germany needed to do more for the bloc.

He said the ECB did not yet fully understand the consequences of all of its actions, given that it was using novel and untested tools, so scrutiny was fair and welcome.

"Little is known to date of the distributional consequences of the unconventional tools we have used, either in respect of their impact or over the medium term," Draghi said.

But in uncharted waters, closer cooperation was needed between fiscal and monetary policy to minimise side effects.

The ECB argues that Germany relies too much on exports, neglecting its internal market and running up huge trade surpluses without recognising that its economic good fortune may not last. More spending at home would balance the German economy and trickle down to the rest of the euro zone, helping the entire bloc, it argues.

Underlining the lack of policy coherence within the euro zone's top economies, however, Italy hiked its budget deficit target for the second time in five months on Tuesday, a move that could set up a clash between Rome and Brussels.

(Writing by Balazs Koranyi; Reporting by Michelle Martin, Michael Nienaber, Francesco Canepa and Balazs Koranyi; Editing by Catherine Evans)