ECB can't allow inflation to remain low for long

The European Central Bank cannot allow eurozone inflation to remain low for too long and is preparing a range of measures to bring it back up to more acceptable levels, its chief economist said on Wednesday. "We mustn't allow inflation to remain too low for too long," ECB executive board member Peter Praet told the weekly newspaper Die Zeit in an interview to be published on Thursday. "No central bank targets zero inflation in the medium term. In a currency union, a moderate rate of inflation facilitates necessary economic adjustment," Praet argued. Area-wide inflation currently stands at just 0.7 percent, a long way off the ECB's target of just under 2.0 percent, fuelling fears that the single currency area is on the brink of deflation. The danger is that deflation, a general and sustained fall in prices, could create a vicious spiral as consumers and businesses hold off spending and investment in anticipation of lower prices down the line. The region's two biggest economies both saw a slight uptick in inflation last month, to 0.7 percent in France and 1.3 percent in Germany, but both rates are still way below the ECB's definition of price stability. "We cannot be satisfied with such a low inflation over the medium term," Praet said. "People must be able to rely on an annual inflation rate of close to but just below 2.0 percent. That's important for their economic decisions. We cannot therefore allow inflation to deviate for a sustained period from the target we have set, either upwards or downwards." ECB chief Mario Draghi gave a strong hint last week that the bank is preparing possible further rate cuts next month to avert looming deflation. The decision-making governing council was "dissatisfied" with the current path of inflation and was "not prepared to accept it as a fact of nature," Draghi said. However, the precise method and extent of any moves would depend on the ECB's updated inflation forecasts, scheduled for next month, Draghi said. - Range of different measures - Praet said that inflation had come in consistently lower than expected in recent months. "The longer it takes to bring inflation back up, the higher is the risk that people's inflation expectations will change. Companies and households would anticipate low inflation rates and adapt their behaviour accordingly. We therefore cannot allow inflation to remain too low for too long," Praet argued. "We're preparing a range of measures," Praet told the newspaper. "We could again lend money to banks for a prolonged period, possibly with certain conditions attached. We could also cut interest rates again. A combination of different monetary policy measures is also thinkable," he said. The ECB's key rates are currently already at all-time lows and more easing would take one of the key rates, the deposit rate, into negative territory for the first time. That would effectively charges banks to park their money with the ECB. But Praet dismissed suggestions that banks would simply pass on the costs to customers, thereby strangling already stifled demand for credit. "With the sort of orders of magnitude we're talking about, I don't expect it'll come to that," Praet said. In addition to cutting rates, the ECB could pump liquidity into the banking system, as it already did two years ago via the so-called long-term refinancing operations or LTROs. This time, it would likely attach conditions to the cash, however, to ensure it was lent on to small and medium-sized enterprises (SMEs) which form the backbone of the eurozone economy. Praet did not, however, see the ECB embarking on US-style quantitative easing unless economic conditions deteriorated. "I think it will only come to that if the eurozone economy and inflation develop significantly worse than we expect," he said.