Euro zone inflation could stay low for longer than expected, says Bank of Finland

HELSINKI, March 24 Mon Mar 24, 2014 5:00am EDT

HELSINKI, March 24 (Reuters) - Inflation in the euro zone could stay low for longer than previously thought, potentially causing difficulties in rebalancing the economy, the Bank of Finland said in its quarterly bulletin.

Annual inflation in the bloc dropped back to 0.7 percent in February to the level that triggered a surprise cut in interest rates in November, underlining deflation risks.

The European Central Bank, which targets inflation at close to but below 2 percent, left borrowing costs unchanged at its most recent meeting on March 6. It considers the risk of euro zone deflation as "quite limited", its president Mario Draghi said earlier this month.

Finnish ECB Governing Council member Erkki Liikanen said on Monday the bank would keep interest rates low well into the euro zone recovery because of high unemployment and the fact that many factories are running well below capacity.

Liikanen, who is also the governor of the Finnish central bank, said the ECB could step in to prop up the economy if needed.

"The Governing Council stands ready to take further decisive action," he said. Liikanen called inflation pressures "moderate".

Euro zone inflation has been in what Draghi calls the "danger zone" of below 1 percent for five months, and the central bank disappointed markets this month when it declined to cut rates from the current 0.25 percent or take other measures to boost the economy.

CRIMEA RISK

Liikanen said that the outlook for the global economy had improved slightly, but added that risks were on the downside, especially in the short term due to the uncertainty caused by the Crimean crisis.

At the same time, financial market confidence and bank funding conditions had improved, and the ECB's health check of the bloc's largest lenders was going to provide an additional boost of confidence, Liikanen said, though it was too early to sound an all clear signal.

Turning to his native country, Liikanen said Finland was going through a serious structural crisis, and that the Crimean crisis would have ripple effects on the already weak economy.

"The fragility of the Russian economy - made worse by the situation in Ukraine - and the contraction in foreign trade will also weaken the Finnish economy," he said.

The Bank of Finland cut its growth forecast for Russia to 0.5 percent, saying that the crisis would slow Russian growth for at least all of this year, even if the tensions subsided quickly. (Reporting by Sakari Suoninen; Editing by John Stonestreet)

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