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Deflationary pressure threat to euro zone

Paris, November 23, 2013

The European Central Bank's (ECB) chief economist said the euro zone faces deflationary pressures, and the bank's president stressed that interest rates must remain low "because the economy is weak".

With euro zone inflation running at 0.7 per cent, well below its target of just under 2 per cent, a raft of ECB speakers this week have said the bank is open to taking fresh measures to support the economy.

Vice-president Vitor Constancio said "everything is possible" and both he and economics chief Peter Praet have said asset buying - or quantitative easing (QE) - is an option.

But the ECB's conservative minority, which voted against this month's surprise cut in interest rates and are led by its German members, still seem dead set against any such move.

Germany's finance minister also warned yesterday that the ECB's loose monetary policy risked giving some euro zone governments an incentive to slow their reforms.

"Monetary policy may not replace the necessity of reducing deficits, fiscal discipline," he added at the European Banking Congress in Frankfurt.

President Mario Draghi has taken a measured line, pouring cold water on the idea the bank was actively considering moving deposit rates into negative territory and stressing the need to keep interest rates low.

"I understand the concerns about a prolonged period of low returns on savings. But it is important to understand that interest rates are low because the economy is weak," Draghi told the meeting.

"If we raised rates, we would further depress the economy, people would lose their jobs, and then their savings would be lower for longer."

Praet, who sits on the ECB's six-strong executive board, said the financial crisis had saddled the euro zone with a debt burden unique in Europe's post-war history because it has created a more deflationary environment.

"This is a very different context for the correction of expectations (about income), which is more of a debt overhang," he told a conference at the Bank of France.

"It has more signs of a balance-sheet recession, which is a priori more of a deflationary environment than what we had in the 1960s."

Another ECB policy maker, Austria's Ewald Nowotny, said in Paris the euro zone was not in deflation, adding: "I do not see a perspective of deflation."

Nowotny is known to have sided with the ECB's hawks in the past and all of this week's comments still added up for economists to a solid divide between the factions.

"They stand ready to act as the November cut proves but they don't yet see a genuine risk of deflation which demands throwing the kitchen sink (at the problem)," said RBS economist Richard Barwell.

"A lot of the chatter is just reminding markets that they still have a sink to throw if they need to."

The economic case for easing ECB policy further was not aided by an above-forecast Ifo sentiment survey out of Germany - one of the month's most watched indicators.

The Ifo survey suggested the euro zone's largest economy continues to recover slowly.

The OECD threw its weight behind the QE idea this week but, in a telling sign of the fierce resistance such an option would face from ECB hawks, Bundesbank chief Jens Weidmann said printing money is not the way out of the euro zone crisis.-Reuters




Tags: Euro zone |

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