* Draghi says ECB must watch for negative price spiral
* May need pre-emptive action if inflation expectations drop
* Ready to use conventional measures; asset-buy plan also an
* Sees "bridging role" for ECB if banks lack funds to lend
* Experts regard ABS plan as tricky to implement
(Adds Reuters poll, comment from experts at ECB forum)
By Eva Taylor
SINTRA, Portugal, May 26 The European Central
Bank must be "particularly watchful" for any negative price
spiral in the euro zone, ECB chief Mario Draghi said on Monday,
adding that the bank was not resigned to inflation being too low
for too long.
The ECB is on guard against deflation and ready to act with
conventional and targeted measures, Draghi said, and a broad
asset-buying plan remains an option.
To guard against a drop in price expectations, "more
pre-emptive action may be warranted", he said in a speech
entitled "Monetary policy in a prolonged period of low
Draghi's comments reinforced suggestions from other ECB
policymakers that the bank is ready to act at its June 5 policy
meeting to counter low inflation and weak lending in the
18-country euro zone.
Draghi said after the ECB's May meeting that the Governing
Council was "comfortable with acting next time" - its June 5
policy meeting - but wanted to see updated economic projections
from the bank's staff first.
He said he expected inflation, now running at 0.7 percent,
to slowly return to the ECB's target of just under 2 percent.
"Our responsibility is nonetheless to be alert to the risks
to this scenario that might emerge and prepared for action if
they do," he said in introductory remarks at the ECB's new Forum
on Central Banking at Sintra in Portugal.
"What we need to be particularly watchful for at the moment
is, in my view, the potential for a negative spiral to take hold
between low inflation, falling inflation expectations and
credit, in particular in stressed countries," he said.
Setting out policy options for different scenarios, Draghi
said that should exchange rate or market developments result in
an unwarranted tightening of monetary and financial conditions
"this would require adjustment of our conventional instruments".
Such instruments include cuts in interest rates, among them
the ECB's deposit rate, now at zero. Cutting that rate below
zero would see the ECB effectively charge banks for holding
their cash overnight.
However, a Reuters poll of euro money-market traders showed
a widely expected cut in the deposit rate would only have a
limited impact on money-market rates in the currency bloc.
Reuters reported earlier this month that the ECB is
preparing a package of policy options for its June meeting. It
includes cuts in all its interest rates as well as targeted
measures aimed at boosting lending to smaller
Draghi indicated that full-blown, U.S.-style quantitative
easing - printing money to buy assets - remained an option for
the ECB, saying a destabilising of inflation expectations "would
be the context for a broad-based asset-purchase programme".
Draghi also fleshed out what he called an "intermediate
situation" in which constraints on credit interfere with the
ECB's monetary policy. That referred to the reluctance of some
banks - particularly in the so-called periphery - to issue loans
as they repair their balance sheets. The recovery would bring
growing demand for credit, Draghi said.
"And at this point, for monetary policy to produce its full
effects, there must be no binding constraints on credit supply
through the banking system," he said.
But he warned that credit demand may pick up faster than
banks can repair their balance sheets and new capital markets
can be developed to complement bank lending.
"If, in this context, availability of term funding is a
limiting factor on loan origination, then monetary policy can
play a bridging role," Draghi said.
"Term-funding of loans, be it on-balance sheet - that is,
through refinancing operations - or off-balance sheet - that is,
through purchases of asset-backed securities - could help reduce
any drag on the recovery coming from temporary credit supply
constraints," he said.
The comments suggested the ECB could deploy a long-term
lending facility - or LTRO - targeted at providing banks with
funds to lend on to businesses and households, or else buy
asset-backed securities (ABS) to support the provision of loans.
ECB Executive Board member Yves Mersch said on Saturday
credit demand in the euro area showed signs of picking up, and
banks needed to be strong enough to respond to that demand.
Hyun Song Shin, economics advisor and head of research at
the Bank for International Settlements, said efforts to help
smaller business were needed but would be hard to implement.
"We have a feast in bond markets and a famine in SME
lending," he told the forum. "If we can drill a hole from very
high liquidity in bond markets into bank lending, of course that
would be exactly what we need, but actually doing that will be
Draghi said credit constraints were hampering recovery in
stressed countries, while the effects of an appreciating euro
exchange rate would hold down euro zone inflation.
However, Stephen Cecchetti, Shin's predecessor at the BIS,
thought the idea of developing an ABS market for loans from
small- and mid-sized companies would be tricky.
"I would like to see an example somewhere in the world of
someone who has successful securitised small- and medium-sized
enterprise loans," Cecchetti said. "I don't think it is a very
easy thing to do."
(Reporting by Eva Taylor; Writing by Paul Carrel; Editing by