Euro zone set for inflation surge - ECB's Constancio

CHICAGO (Reuters) - Euro zone inflation will accelerate quickly in coming months and a recent string of encouraging economic data may have reduced risks to growth, European Central Bank Vice President Vitor Constancio said on Friday.

European Central Bank (ECB) president Mario Draghi (R) and vice president Vitor Constancio attend a news conference at the ECB headquarters in Frankfurt, Germany, July 21, 2016. REUTERS/Ralph Orlowski

Facing the threat of deflation, the ECB has bought well over 1 trillion euros of assets in the past year and a half to stimulate growth and consumer prices, only to see inflation hover either side of zero.

But relatively resilient growth and rising oil prices pushed annual inflation to a more than two-year high of 0.5 percent last month and Constancio predicted a rate of 1.3 percent by March.

That is still well short of the bank’s close to 2 percent target but is still likely to fuel calls from the hawks on the ECB’s rate-setting Governing Council to dial back a stimulus programme that includes 80 billion euros of asset purchases per month, sub-zero rates and free loans to banks.

The ECB will have to decide next month whether to extend the purchases beyond their scheduled end in March and while an extension is still fully priced in, a rapid inflation rise could still temper those expectations.

“It’s a conditional statement, but nevertheless, I risk to make (it)... Finally, we are seeing a trend toward more reasonable levels of inflation in Europe, which I hope will then help the dynamic with wage increases,” Constancio told a conference in Chicago.

Recent indicators including PMI, employment and sentiment data have been stronger than expectations and Constancio said he was encouraged by the recent news flow, which may have reduced the downside risk in the ECB’s projections.

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The ECB has long warned that while growth appeared resilient, it was subject to negative risks, a warning taken to mean it will be very careful not to remove stimulus too early.

Although negative interest rates will be temporary, Constancio said that the ECB’s expanded balance sheet may be may be here to stay, functioning as a policy instrument.

Although the assets purchases will eventually end, Constancio’s comments suggested the ECB may still want to retain its influence on the entire yield curve and could used its expanded up balance sheet of over 3.5 trillion euros as a policy tool.

“A number of potential changes to monetary policy frameworks could be necessary to meet the challenges of the new economic environment,” he said.

Writing by Balazs Koranyi; editing by John Stonestreet