ECB should buy euro zone assets - OECD

The European Central Bank must consider buying government and corporate bonds to help the euro zone avoid a Japanese-style deflationary spiral, the OECD said today.

It was a direct call for the ECB to undertake quantitative easing, a policy that currently divides the bank, in the face of what the think-tank said was a risk of deflation.

Inflation in the 17-nation euro zone fell to its lowest in nearly four years in October, with the economy struggling to recover strongly after emerging from its longest ever recession.

Despite a surprise ECB rate cut this month, the Organisation for Economic Co-operation and Development said in its latest economic outlook that the bank needs to take bolder measures at a time of massive unemployment and difficult credit.

“Risks of deflation may be slowly increasing,” OECD chief economist Pier Carlo Padoan told Reuters. “The ECB must be very careful and be prepared to use even non-conventional measures to beat any risk of deflation becoming permanent,” he said.

Under its statutes, the ECB is banned from buying bonds directly from governments but can find ways to purchase them from banks, for example, on the secondary market or accept them as security in return for finance.

The euro zone is still far from the deflation that Japan suffered from the early 1990s, when falling prices weakened demand, leading to wage cuts and even lower prices.

But Ireland, Cyprus and Greece all registered deflation in October and for the euro zone as a whole, consumer prices actually fell in October from September, by 0.1 percent.

The OECD’s call follows comments by ECB executive board member Peter Praet in an interview this month that asset purchases were one of the tools available to the central bank beyond interest rate cuts.

The comments signalled that the ECB, having cut rates so low and provided liquidity to banks, may be considering the controversial move of asset purchases because it has few other options, although it is not clear if that would emulate the US-style quantitative easing programme.

The ECB injected more than €1 trillion into the banking system via ultra-cheap three-year loans in December 2011 and February 2012.

The ECB has run its own bond purchases programmes in the past but has always withdrawn an equivalent amount of money from markets - in effect not printing new money - to ensure its interventions have no impact on the money supply for fear of pushing up the rate of inflation.

With inflation at 0.7 per cent in October and well below the ECB’s target of just below 2 per cent, that argument has been greatly weakened.

The OECD painted a sobering picture in its outlook for the euro zone as the bloc tries to recover from the public debt and banking crises that nearly shattered the currency area.

Economic output is set to grow just 1 per cent next year after contracting 0.4 per cent in 2013, while the unemployment rate will not fall until 2015, the OECD said, putting its forecasts largely in line with the European Commission.

However, the OECD sees annual inflation at 1.2 per cent in 2014 and 2015, below the Commission’s latest forecasts of 1.4 per cent and 1.5 per cent respectively.

Reuters