European Central Bank President Mario Draghi said on Monday that the bank remains alert to the risks to a prolonged period of low inflation and expressed readiness to take action if required.
At an ECB forum in Sintra, Portugal, Draghi said a prolonged period of low inflation would call for a more expansionary stance, which would also include the asset purchase programme.
If a temporary shock turns more persistent, any monetary policy response might arrive too late, he said, suggesting more pre-emptive action from the central bank.
Markets expect expansionary actions from the ECB as hinted by Draghi at the post decision press conference in May. The central bank chief said the bank would decide on further action after seeing the June macroeconomic projections.
"What we need to be particularly watchful for at the moment is the potential for a negative spiral to take hold between between low inflation, falling inflation expectations and credit, in particular in stressed countries," he said today.
There is a risk that disinflationary expectations take hold and that may cause households and firms to defer expenditure in a classic deflationary cycle, Draghi warned.
Banks may respond to this situation with stricter credit standards and worsens debt burden. "This is fertile ground for a pernicious negative spiral, which then also affects expectations," Draghi said.
Term-funding of loans, be it on-balance sheet or off-balance sheet, it could help reduce any drag on the recovery coming from temporary credit supply constraints, the central banker added.
Further, he said, "We are not resigned to allowing inflation to remain too low for too long."
Inflation has remained below the ECB's target of 'below, but close to 2 percent' for the fifteenth consecutive month in April.
IHS Global Insight's Chief European Economist Howard Archer said the ECB seems highly likely to cut its refinancing rate from 0.25 percent to 0.15 percent or 0.10 percent and to take its deposit rate marginally into negative territory.
It is also looks probable that the ECB will take some liquidity measures in June, he added. However, Archer said he is doubtful that the bank will undertake full blown quantitative easing.
by RTT Staff Writer
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