European Central Bank policymakers played down the threat of deflation today and said it was important not to overreact to the financial crisis and cut interest rates too far, too fast.
ECB executive board member Lorenzo Bini Smaghi called the risk of deflation "remote", while Greek central bank chief George Provopoulos said the rate cuts and government stimulus together should help prevent a spiral of falling prices.
"While a number of factors suggest that inflationary pressures will decline significantly, there are currently no signs of deflationary expectations," Mr Bini Smaghi said in a speech in Venice.
"As long as inflation expectations remain firmly anchored, deflation will therefore remain a rather remote risk."
Speaking later in Madrid, Mr Bini Smaghi said rapid and large interest rate cuts could fail to cut borrowing rates for households and firms.
He cited the case of the United States where policy rates are lower than 1 per cent but rates for mortgages and companies are in most cases higher than in the euro zone, where the European Central Bank has a policy rate of 3.25 per cent.
"There is a risk that the policy action, even when rapid and ample, does not succeed in reversing the trend," he said. "There is a risk policymakers run out of ammunition too early and remain without a means to escape."
Two quick-fire 50 basis point cuts since October have cut benchmark euro zone interest rates to 3.25 per cent and analysts think they could go to 2 per cent or lower next year if the region's current recession evolves into a major long-term slump.
Inflation eased to 3.2 per cent from a peak of 4 per cent in June and July and is expected to keep falling as growth and oil prices ease, leaving room for the ECB to cut rates further.
Mr Bini Smaghi's warnings against overly drastic rate cuts were echoed by Austria's Ewald Nowotny. "It makes sense to be rather cautious and keep some of the firepower, and that means of course that you cannot use it up all in one go," Mr Nowotny said in an interview with news agency Bloomberg, bolstering analysts' expectations for another half-point cut on December 4th.
Mr Nowotny did not rule out rates dropping to 2 per cent - which economists see by the second quarter next year - although he was not quoted directly as saying so. But he played down the prospect of bumper cuts. "The way the ECB has acted so far, I believe that we'll continue in this manner," he said.
Reuters