Appeal to keep interest rates low as weakened Eurozone fears for deflation

THE European Central Bank’s chief economist has said the eurozone 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 two per cent, a raft of ECB speakers this week have said it is open to taking fresh measures to support the economy.

Vice-President Vitor Constancio said on Tuesday “everything is possible” and both he and economics chief Peter Praet have said asset buying – or quantitative easing (QE) – is an option after years in which the bank’s policymakers have ruled it out.

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But the more conservative minority at the bank, who 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.

President Mario Draghi has taken a measured line, on Thursday pouring cold water on the idea the bank was actively considering moving deposit rates into negative territory and on Friday 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,” Mr Draghi told the European Banking Congress in Frankfurt.

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

Mr Praet, who sits on the ECB’s six-strong executive board, said the financial crisis had saddled the eurozone 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 policymaker, Austria’s Ewald Nowotny, told reporters in Paris the eurozone was not in deflation.

He added: “I do not see a perspective of deflation.”

Mr Nowotny is known to have sided with the ECB’s hawks in the past and all of this week’s sounding off still added up for economists to a solid divide between the factions. RBS economist Richard Barwell said: “A lot of the chatter is just reminding markets that they still have a sink to throw if they need to.”