(Adds remarks on threat to recovery, paragraphs 1, 4-8)
By Alastair Sharp
MONTREAL, June 9 European Central Bank
policymaker Christian Noyer highlighted low and falling
inflation on Monday as Europe's main short-term problem, saying
it heightened the risk of actual deflation and could threaten
"The main challenge, of course, is low and declining
inflation, with inflation expectations in the euro area drifting
downward at short to medium-term horizons," Noyer, the French
central bank chief and member of the ECB board, told the
economic Conference de Montreal.
"This prevents adjustments in relative prices, an important
mechanism to eliminate gaps in competitiveness, and it increases
the risk of outright deflation, should a negative shock occur in
It is puzzling that in the euro area inflation and growth
are moving in opposite directions, he said: "As growth
accelerates, inflation keeps going down."
To try to understand why, he looked at strong capital
inflows into euro area economies in recent months, which had two
opposite effects on financial conditions - lower long-term
interest rates but an appreciation of the euro exchange rate.
"It's not clear whether the overall effect is positive.
While nominal conditions are more accommodating in (the) euro
area than in the U.S., real indicators point to a more
restrictive stance," he said.
"We may see a perverse feedback loop develop, with low
inflation, increasing real rates, capital inflows and exchange
rate appreciation mutually fueling each other. The financial
economy may be heading towards a bad equilibrium that would
threaten the real economic recovery."
He said such a situation called for a real policy response,
which is why the ECB brought in a series of strong measures last
Thursday, including imposing negative interest rates on
(Writing by Randall Palmer in Ottawa; Editing by Chizu Nomiyama
and Tom Brown)