ECB must fight spectre of 'Japanification': de Guindos, Rehn

Credit: REUTERS/LEHTIKUVA

The European Central Bank must battle low inflation expectations to keep them from becoming self-fulfilling, the sort of misfortune Japan has struggled with for years, two policymakers said on Thursday.

Combines Rehn and de Guindos

MADRID/HELSINKI, Oct 3 (Reuters) - The European Central Bank must battle low inflation expectations to keep them from becoming self-fulfilling, the sort of misfortune Japan has struggled with for years, two policymakers said on Thursday.

The ECB loosened policy further last month to lift growth and inflation, sparking an unusual public spat between its doves and more conservative policymakers from the northern euro zone.

"We have learned from the experience in Japan that it is possible to get caught in a vicious cycle of declining inflation expectations, falling inflation and a binding lower bound on nominal interest rates from which it is difficult to escape," ECB Vice President Luis de Guindos said on Thursday.

The ECB cut its key rate to minus 0.5 percent last month, inching closer to what is the effective bottom, a level beyond which it would be counterproductive to go.

Finnish central bank chief Olli Rehn said that accepting low inflation would constrain the ECB, making monetary policy less effective and reducing its ability to counter economic cycles.

"We should take care to avoid the sort of harmful equilibrium that arises from prolonged low inflation and zero interest rates, as this would significantly constrain the capacity for monetary policy to balance the economic cycle," Rehn said in Helsinki.

"This would bring about a lengthy shortfall in economic growth with respect to its potential and hinder efforts to boost employment," Rehn said, also pointing to Japan's dilemma.

The ECB aims for inflation at just below 2 percent, but it has undershot that target since 2013. Its projections show it has little hope of reaching it for years to come.

Markets' inflation outlook EUIL5YF5Y=R initially rose on the September stimulus pledge, but they have now fallen on expectations growth will slow further.

De Guindos said part of the solution would be creating a sizeable and agile centralised fiscal capacity in the euro zone, which should play a more substantive role than usual in boosting the euro zone economy.

"A dedicated centralised fiscal capacity would not interfere with domestic policy," de Guindos said in Madrid. "By focusing on common area-wide stabilisation, it need not affect national fiscal space but rather provide an additional layer."

(Reporting by Anne Kauranen and Jesus Aguado, writing by Balazs Koranyi, editing by Larry King)

((Balazs.Koranyi@thomsonreuters.com; +49 69 7565 1244; Reuters Messaging: balazs.koranyi.thomsonreuters.com@reuters.net))

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