Mario Draghi said inflation expectations have deterioratedacross the euro area and signaled policy makers are ready to addfresh monetary stimulus.

In his strongest indication yet that officials aren't finishedwith measures to stave off a Japan-style stagnation, the EuropeanCentral Bank (ECB) president told his international counterparts inJackson Hole, Wyoming, today that investor bets on euro-areainflation have “exhibited significant declines at all horizons” inAugust.

“The Governing Council will acknowledge these developments andwithin its mandate will use all the available instruments needed toensure price stability over the medium term,” Draghi said inad-libbed remarks during a speech at the Federal Reserve Bank ofKansas City's annual economic symposium.

The comments come days before data that is predicted to showeuro-area inflation slowed to 0.3 percent this month, a fraction ofthe ECB's goal and the weakest since October 2009. The 18-nationeconomy stalled in the second quarter and unemployment remains neara record high.

Draghi's concern is that the malaise prompts investors,consumers, and companies to pull back spending in anticipation ofeven weaker inflation, tipping Europe into a deflationary spiralthat would be hard to reverse.

He cited the ECB's preferred gauge for inflation expectations,which fell below 2 percent this month. The last time the 5-year,5-year inflation swap rate crossed that level, which matches thecentral bank's price-stability threshold, was in October 2011,according to data compiled by Bloomberg.

The backdrop of a stalled economy and slowing price gains, addedto the trade risks surrounding escalating sanctions against Russiabecause of its support of separatists in Ukraine, is raisingspeculation the ECB will embark on quantitative easing (QE).Citigroup Inc. economists said today they predict a 1 trillion euro(US$1.3 trillion) package of broad-based asset purchases will beunveiled in December.

“The odds of such a program are rising, although whether or notit will happen is still very much uncertain,” Roberto Perli, apartner at Washington-based Cornerstone Macro LP, said after Draghispoke. “Still, the odds of QE are going up, and that is probablymore important for the markets than the exact date when QE mightbegin.”

Existing Stimulus

Draghi made no mention of quantitative easing in his speech,instead highlighting steps the ECB is already taking to bolster theeconomy. The central bank cut interest rates to record lows in June, and will next monthstart a round of cheap funding for banks linked to loans to thereal economy. It is also “fast moving forward” with a program forbuying asset-backed securities, and the euro area should benefitfrom a weaker currency, he said. The euro slid to an 11-month lowagainst the dollar today.

He said that while he is “confident” that the package ofmeasures will work, “we stand ready to adjust our policy stancefurther.” He also warned that there is a “real risk” that monetarypolicy loses some effectiveness.

The ECB's Governing Council next meets to set monetary policy onSept. 4 in Frankfurt. It has so far avoided QE amid political andlogistical concerns over how such a program would be carriedout.

Draghi intensified pressure on European governments to playtheir part, saying “it would be helpful” if those with room to easefiscal policy did so.

“We need action on both sides of the economy: Aggregate demandpolicies have to be accompanied by national structural policies,”Draghi said. “We should not forget that the stakes for our monetaryunion are high.”

He proposed four areas in which fiscal policy could be improved:better use of flexibility within existing European Union rules;lower taxes; stronger fiscal coordination between governments; andEU action to ensure a large public investment program.

Countries including France and Italy have argued for moreflexibility with their budgets, and French Finance Minister MichelSapin said this month that his nation will exceed a deficit targetagreed upon less than four months ago with the European Commission.Germany has said governments should stick to the rules on fiscalgoals.

“No amount of fiscal or monetary accommodation, however, cancompensate for the necessary structural reforms in the euro area,”Draghi said. These reforms “can no longer be delayed.”

The ECB's economic outlook increasingly contrasts with that ofthe U.S. central bank. Fed Chair Janet Yellen told the Jackson Holeconference that the U.S. labor market has made “considerableprogress,” though too many Americans are still out of work. Fedofficials are slowing monetary stimulus and debating when to exitfrom ultra-loose policy.

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