Mario Draghi said the European Central Bank (ECB) might startbroad-based asset purchases if the inflation outlook worsens as heprepares the ground for one of the most radical policies in theECB's history.

“The objective here would not be to defend the current stance,but rather to increase meaningfully the degree of monetaryaccommodation,” the ECB president said in a speech in Amsterdamtoday. “The Governing Council is committed—unanimously—to usingboth unconventional and conventional instruments to dealeffectively with the risks of a too-prolonged period of lowinflation.”

Draghi's comments are his most explicit so far on what wouldprompt action similar to the quantitative easing programs at theU.S. Federal Reserve and Bank of England. Inflation data next weekwill give further clues as to whether consumer-price gains areaccelerating as the economy recovers or if the euro area isteetering close to deflation.

“Draghi was very precise in explaining when and how the ECB willchoose to act,” said Johannes Gareis, an economist at Natixis inFrankfurt. “The ECB is unlikely to embark on broad-based assetpurchases unless the ECB feels real deflationary risks.”

The euro fell after Draghi's comments. It was little changed at$1.3811 at 4:38 p.m. Frankfurt time. Germany's benchmark 10-yearbond yield slid five basis points to 1.517 percent.

Euro Strength

Inflation in the 18-nation currency bloc slowed to 0.5 percentlast month, the weakest pace in more than four years and well belowthe ECB's goal of just under 2 percent. While that prompted Draghito say on April 3 that policy makers are willing to useunconventional measures, including asset purchases if needed, healso said the figure was depressed by temporary factors such aslower energy and food prices and the timing of Easter. This month'sdata is due on April 30.

“While inflation will remain low for a prolonged period, we seeit gradually rising back to 2 percent,” Draghi said today. “Thedelay is largely explained by the impairments in the transmissionmechanism that lengthen the lag between our accommodative policystance and price developments.”

Draghi said that any asset-purchase program “should certainlytake into account the heterogeneity, the fragmentation let's callit, of our euro-area system, if that is relevant for theeffectiveness of the purchase program.”

His words echo comments made by Executive Board member BenoitCoeure on April 13 in Washington. Coeure warned that “segmentationwould have to be taken into consideration” to ensure a purchaseprogram in the euro area achieved a “homogeneous reduction” oflonger-term interest rates.

Draghi said that the ECB doesn't see broad-based deflationrisks, while adding that a stronger euro exchange rate doesthreaten the outlook for prices.

“A rise in the exchange rate, all else being equal, implies atightening of monetary conditions, a downward impact on inflation,and potentially a threat to the ongoing recovery,” he said. “If so,this would call for policy action to maintain the currentaccommodative stance.”

An unwarranted monetary tightening because of euro strengthcould be addressed by conventional measures including cuts inofficial interest rates, he said. The ECB has kept its benchmarkmain refinancing rate at a record-low 0.25 percent since November,and the deposit rate has been at zero since July 2012.

ECB Governing Council member Luc Coene said later in Amsterdamthat a strong euro “certainly is a problem” in that it putsdownward pressure on prices that are already low, and reiteratedDraghi's comments on the possible policy response.

“If you only cut the main refinancing rate, that is going to bea very small adjustment that will not have sufficient impact on themarkets,” he said. “You should cut both and bring the wholecorridor down.”

Conventional policy action could also be warranted by tensionsin short-term money markets “in an environment of receding excessliquidity in the euro area,” Draghi said.

Excess liquidity in the euro-area financial system has droppedto 92.9 billion euros (US$128 billion), the lowest level sinceDecember 2011, the ECB said today. The decline is adding topressure on the ECB to curb money-market tensions, according tostrategists at Rabobank.

ECB Minutes

Draghi also said publishing minutes is the “logical next step”in the ECB's efforts to improve transparency and accountability,and this might in turn trigger a reflection on how often the bankdecides on monetary policy.

“It's very clear that the frequency of our meeting leads thepublic and the market to expect action,” he said, adding this washis view and not necessarily the Governing Council's.

The ECB holds a rate-setting meeting once every month, moreoften than other central banks such as the Fed. The Bank of Japanis scheduled to hold 14 monetary policy meetings in 2014. The ECB'snext rate meeting is on May 8 in Brussels.

“It's obvious that the frequency we have now is leading to somepressures to act more frequently than basically is needed in amedium-term framework,” said Coene. “So you could argue that maybeit would be more optimal to have policy meetings not at everymonth, but at a greater interval.”

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