The ECB is on guard against deflation and ready to act with
conventional and targeted measures, Draghi said, and a broad
asset-buying plan remains an option.
To guard against a drop in price expectations, "more pre-emptive
action may be warranted", he said in a speech entitled "Monetary
policy in a prolonged period of low inflation".
Draghi's comments reinforced suggestions from other ECB policymakers
that the bank is ready to act at its June 5 policy meeting to
counter low inflation and weak lending in the 18-country euro zone.
Draghi said after the ECB's May meeting that the Governing Council
was "comfortable with acting next time" - its June 5 policy meeting
- but wanted to see updated economic projections from the bank's
staff first. He said he expected inflation, now running at 0.7
percent, to slowly return to the ECB's target of just under 2
"Our responsibility is nonetheless to be alert to the risks to this
scenario that might emerge and prepared for action if they do," he
said in introductory remarks at the ECB's new Forum on Central
Banking at Sintra in Portugal.
"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
low inflation, falling inflation expectations and credit, in
particular in stressed countries," he said.
Setting out policy options for different scenarios, Draghi said that
should exchange rate or market developments result in an unwarranted
tightening of monetary and financial conditions "this would require
adjustment of our conventional instruments".
Such instruments include cuts in interest rates, among them the
ECB's deposit rate, now at zero. Cutting that rate below zero would
see the ECB effectively charge banks for holding their cash
However, a Reuters poll of euro money-market traders showed a widely
expected cut in the deposit rate would only have a limited impact on
money-market rates in the currency bloc.
Reuters reported earlier this month that the ECB is preparing a
package of policy options for its June meeting. It includes cuts in
all its interest rates as well as targeted measures aimed at
boosting lending to smaller firms. Draghi indicated that full-blown,
U.S.-style quantitative easing - printing money to buy assets -
remained an option for the ECB, saying a destabilizing of inflation
expectations "would be the context for a broad-based asset-purchase
Draghi also fleshed out what he called an "intermediate situation"
in which constraints on credit interfere with the ECB's monetary
policy. That referred to the reluctance of some banks - particularly
in the so-called periphery - to issue loans as they repair their
balance sheets. The recovery would bring growing demand for credit,
"And at this point, for monetary policy to produce its full effects,
there must be no binding constraints on credit supply through the
banking system," he said.
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But he warned that credit demand may pick up faster than banks can
repair their balance sheets and new capital markets can be developed
to complement bank lending.
"If, in this context, availability of term funding is a limiting
factor on loan origination, then monetary policy can play a bridging
role," Draghi said.
"Term-funding of loans, be it on-balance sheet that is, through
refinancing operations or off-balance sheet that is, through
purchases of asset-backed securities could help reduce any drag on
the recovery coming from temporary credit supply constraints," he
The comments suggested the ECB could deploy a long-term lending
facility - or LTRO - targeted at providing banks with funds to lend
on to businesses and households, or else buy asset-backed securities
(ABS) to support the provision of loans.
ECB Executive Board member Yves Mersch said on Saturday credit
demand in the euro area showed signs of picking up, and banks needed
to be strong enough to respond to that demand.
Hyun Song Shin, economics advisor and head of research at the Bank
for International Settlements, said efforts to help smaller business
were needed but would be hard to implement.
"We have a feast in bond markets and a famine in SME lending," he
told the forum. "If we can drill a hole from very high liquidity in
bond markets into bank lending, of course that would be exactly what
we need, but actually doing that will be very challenging."
Draghi said credit constraints were hampering recovery in stressed
countries, while the effects of an appreciating euro exchange rate
would hold down euro zone inflation.
However, Stephen Cecchetti, Shin's predecessor at the BIS, thought
the idea of developing an ABS market for loans from small- and
mid-sized companies would be tricky.
"I would like to see an example somewhere in the world of someone
who has successful securitized small- and medium-sized enterprise
loans," Cecchetti said. "I dont think it is a very easy thing to
(Reporting by Eva Taylor; Writing by Paul Carrel; Editing by Larry
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