ECB says it is ready to take action if low inflation ‘entrenched’

European Central Bank president Mario Draghi signalled policy makers are ready to take action in June should they see low inflation becoming entrenched.

"What we need to be particularly watchful for at the moment is, in my view, the potential for a negative spiral to take hold between between low inflation, falling inflation expectations and credit, in particular in stressed countries," Mr Draghi said in a speech at the ECB Forum in Sintra, Portugal. "The key issue today, however, is timing."

Mr Draghi is trying to guide the euro area through a fragile economic recovery that remains threatened by subdued pricing power.

Officials have said they’re working on a package of possible measures for the June 5th policy meeting, including interest-rate cuts and liquidity injections, while holding out the prospect of asset purchases as a more powerful option. The ECB president didn’t elaborate on any possible measures, after saying on May 8th that officials are “comfortable” with acting next time and willing to use unconventional instruments if needed. “We are not resigned to allowing inflation to remain too low for too long,” he said today. “There is no debate about our goal, which is to return inflation toward 2 per cent in the medium-term, in line with our mandate.”

ECB vice president Vitor Constancio said the conference won't address current monetary-policy issues, and will focus on academic research papers.

The event in Sintra is the ECB’s answer to the US Federal Reserve’s annual monetary conference in Jackson Hole, Wyoming. Nobel Laureate Paul Krugman and Princeton University’s Markus Brunnermeier are among the delegates to address the getaway at Penha Longa.

IMF managing director Christine Lagarde delivered the opening address yesterday, and warned policy makers that a new range of instruments to bolster financial stability, known as macroprudential tools, aren't proven.

ECB executive board members Constancio, Peter Praet and Benoit Coeure will chair panel discussions today and tomorrow, which will include examinations of the role of such instruments in the central-bank repertoire. Mr Draghi will wrap up with closing remarks tomorrow afternoon.

In his speech today, the ECB president said a prolonged period of low inflation can lead to higher-than-expected debt burdens and prompt lenders to tighten their credit standards.

“This is fertile ground for a pernicious negative spiral, which then also affects expectations,” he said.

Inflation in the 18-nation euro area has been below 1 percent since October, less than half the ECB’s goal, and economies from Italy to the Netherlands contracted in the first quarter. Unemployment was 11.8 per cent in March, near the record 12 per cent reached last year.

Ninety per cent of economists in the Bloomberg Monthly Survey predict the ECB’s Governing Council will ease policy in June. Most forecast a simultaneous cut in the benchmark rate, now at 0.25 per cent, and the deposit rate, which is at zero. That would make the ECB the first major central bank to charge for holding lenders’ excess cash overnight. (Bloomberg)