FRANKFURT European Central Bank chief Mario Draghi has whetted markets' appetite for more ECB policy action but investors will have to wait some time before he uses the only real option he has left - a major asset-buying plan.
First he will want to assess the effectiveness of the loosening package he presented on Thursday - rate cuts and measures to pump money into the sluggish euro zone economy. Then he will also have to overcome German resistance if he wants to do anything further.
Bundesbank chief Jens Weidmann has already fired a shot across Draghi's bows, saying it is "absurd" to talk about further policy action.
Except for so-called quantitative easing (QE) - or money printing to buy assets - there is little left in the ECB armory after Thursday's announcement of new measures to try to steer the euro zone away from the economic quicksand of deflation.
Draghi's comment after presenting the package that "we aren't finished here" clearly indicates QE is on the table. But the ECB first wants to assess how the new measures work - and they will only dribble out over the rest of this year.
ECB Vice President Vitor Constancio, a dove on the Governing Council, said on Friday it would take the ECB until December to assess whether these steps had succeeded.
Constancio also stressed just how high the bar is to QE:
"If we see a sort of vicious circle emerge out of (low)inflation and an unanchoring of expectations and an outward shock that would create a reverse spiral, that would require a broad program of asset purchases," he said in London.
The ECB does not expect such a vicious circle but it is facing a morose economic outlook. Updated ECB staff forecasts included a cut in the inflation forecast for this year to a mid-point of 0.7 percent from 1.0 percent in March.
The ECB experts saw inflation averaging just 1.5 percent in the final quarter of 2016 - still below the ECB's target of just under 2 percent.
What is more, the ECB has used all the meaningful measures it has apart from QE. Draghi made clear that after Thursday's cuts in interest rates to record lows "for all the practical purposes" the bank had run out of room to lower them further.
The new package also included a series of measures to pump money into the sluggish euro zone economy.
"Everything has been done now," said RBS economist Richard Barwell. "The only thing they've got left now is a broad-based asset purchase program."
"If we get bad news, the logical response from the market will be: you've got nothing else, you've got to do QE now."
But the ECB may have boxed itself into a corner should the inflation outlook deteriorate further.
In an April 24 speech in Amsterdam, Draghi set out three scenarios that would warrant ECB action: a de facto tightening of the bank's policy stance due to market tensions, problems transmitting its policy to all parts of the euro zone, and a deterioration of the medium-term inflation outlook.
With Thursday's announcements, the ECB addressed the first and second scenarios, leaving only a bleaker inflation outlook as grounds for action. Draghi said in Amsterdam the response for this scenario would be a broad-based asset purchase program.
"Their own narrative will now start boxing them in. Draghi's speeches were very clear," said Barwell. "They cannot risk sounding complacent if the situation deteriorates, or we will be right back to square one with an appreciating euro and markets questioning their commitment to price stability."
Despite Thursday's rate cuts and the announcement of measures to pump money into the sluggish euro zone economy, the euro EUR= ended up rising once markets had digested the ECB package, which, in fairness, had been widely expected.
A stronger euro gives consumers in the currency area more purchasing power over imported goods, exacerbating the bloc's weal inflation dynamics. Any policy inaction that drives up the currency further will only add to the ECB's policy conundrum.
For Nobel Prize-winning economist Paul Krugman, the ECB is already caught tight by deflationary forces, even if you don't yet actually have overall deflation like that which gripped Japan for many years.
Euro zone inflation slowed to 0.5 percent in May.
"People ask me: is it possible Europe could turn into Japan? The answer is 'yeah'," Krugman said in Rotterdam on Thursday. "The hard part is telling a story in which Europe does not turn into Japan."
The ECB releases its next staff inflation forecasts in September - a potential trigger for any further policy action, should the outlook deteriorate.
The new ECB measures include cuts in interest rates to record lows, the injection of liquidity into the financial system, a long-term refinancing operation (LTRO) to encourage banks to lend to firms and work on the ECB buying asset-backed securities (ABS).
The LTRO funding offers will be made in September and December, while the ECB is still working on the plan to buy ABS - so it will take time for the new package to take effect.
In Germany, this bid to jump-start Europe's economy has been greeted with dismay, Draghi's policy denounced as a "risky therapy" that could fuel U.S.-style asset bubbles and discourage reform in crisis-hit euro states. [ID:nL6N0ON1F2]
Chancellor Angela Merkel was noticeable in her absence among those congratulating the ECB on Thursday.
Draghi will meet Merkel in Berlin next Wednesday, a German government spokeswoman said, without providing further details.
Securing Merkel's support would help Draghi if he wanted to pursue QE but his stiffest opposition would likely come from The Bundesbank's Weidmann, Merkel's former economics adviser.
Weidmann, who spent his formative years at the Bundesbank before his time with Merkel, is an arch-hawk who was the sole ECB policymaker to oppose Draghi's signature policy - the OMT bond-buy plan launched in 2012 to back-up the Italian's pledge to do "whatever it takes" to save the euro.
"The ECB has acted with a very broad set of measures," Weidmann told Germany's Bild newspaper. "Now we have to wait and see how the measures take effect. It would be absurd to already start talking now about a further set of measures."
(Writing by Paul Carrel Editing by Jeremy Gaunt)