Interest rate cuts alone will not fix the challenges facing the euro zone economy and it would be reasonable for the European Central Bank to keep rates on hold at 2 per cent, the OECD said in a report today.
Less than two months ago, in a separate report, the Organisation for Economic Cooperation and Development urged the ECB to "significantly" cut rates to help the flagging economy.
"It would seem reasonable for the ECB to hold its rate stable as long as the outlook for price developments remains in line with price stability over the medium term," the OECD said in its latest survey of the 12-nation euro area economy.
But the central bank must keep a close eye on inflation for any changes that could warrant a policy move. "Policy would need to act if the inflation outlook were to change," the report added.
Last Thursday, the ECB kept its key rate on hold at 2 per cent for the 25th month in a row, refusing to bow to pressure from politicians to cut rates to boost a faltering economy.
The OECD said the impact of monetary policy on the economy would be limited without accompanying structural reforms.
"There is little monetary policy can do on its own to boost the euro area economy: interest rates cuts are not the panacea, and foreign exchange intervention appears undesirable," it said.
The report warned the euro zone that if it does not move ahead with key reforms such as making labour markets more flexible and integration of services markets, it risks a widening income gap with the United States.
"Boosting the poor growth performance to date requires stepping up the pace of structural reforms and restoring sound public finances," the OECD wrote.
The report highlighted "significant" downside risks to the outlook for economic growth in the area. In its May report, the OECD forecast 2005 growth at 1.2 per cent climbing to 2.0 percent in 2006.
It will update its economic forecasts in September. The outlook for the euro area is for a gradual recovery but there were risks to this forecast, the OECD said.