Praet - Weaker oil prices may call for more ECB action: paper

FRANKFURT (Reuters) – The European Central Bank’s chief economist said weaker oil prices could unhinge inflation expectations and that the ECB may need to launch quantitative easing (QE) to keep prices stable.

Peter Praet told Boersen-Zeitung there was a risk that ECB measures including cutting rates to record lows, offering banks cheap long-term loans and buying secured private debt, might not be enough – especially against a backdrop of weaker oil prices.

Praet said the plunge in oil prices could mean euro zone inflation is negative during “a substantial part of 2015″ and that price competition resulting from weaker oil prices could contribute to “the de-anchoring of inflation expectations”.

Were ECB interest rates not already near zero, “there would have been a unanimous decision to cut rates”.

“If my assessment is that there is a need for further accommodation, and if I were willing to cut rates if that had been possible, then I should not be paralysed by the fact that the only option is to buy sovereign bonds,” Praet said.

“Unfortunately” sovereign bonds were the only securities with significant market volume, he said, adding that the corporate bond market was too small and bank bond purchases could raise concerns as the ECB is also the bank supervisor.

There has been substantial opposition to large-scale purchases of sovereign bonds, especially from Germany, which fears such a step would ease pressure on governments to reform and force it to stand in for risks accumulated elsewhere.

Praet said there had not been a decision on how to deal with the issue of risk-sharing should the Governing Council decide to launch sovereign QE, or bond purchases with new money, which it could do as early as at its next policy meeting on Jan. 22.

He said one option would be to buy according to the outstanding debt of a country, but this would lead to a higher degree of risk-sharing. Another option would be purchases without loss-sharing in the event of default.

Finally, the ECB could minimise risks by buying only top-rated bonds, but here much bigger volumes would be needed to have the desired impact on inflation, Praet said.

Euro zone inflation stands at 0.3 percent and ECB staff expect it to reach 0.7 percent next year. But those projections were made before this year’s huge drop in oil prices, which fell to 5-1/2 year lows on Tuesday.

“With the recent oil prices, inflation would be even lower, even substantially lower than expected so far. This is especially true for 2015 — when the effect would amount to 0.3 to 0.4 percentage points, which could mean negative inflation during a substantial part of 2015,” Praet said.

“Some might say we should ‘look through’ it again, as we always did in the past.

“Others might say — and I personally lean towards that argument — that in an environment in which headline inflation might become negative and in which inflation expectations are extremely fragile we cannot simply ‘look through’.”

(Reporting by Eva Taylor; Editing by Catherine Evans)

Praet - Weaker oil prices may call for more ECB action: paper