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ECB's Praet warns of deflationary pressures in euro zone

Mario Draghi, President of the European Central Bank
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Mario Draghi, President of the European Central Bank

The European Central Bank's chief economist said on Friday the euro zone faces deflationary pressures, and the bank's president stressed that interest rates must remain low "because the economy is weak''.

With euro zone inflation running at 0.7 percent, well below its target of just under 2 percent, a raft of ECB speakers this week have said it is open to taking fresh measures to support the economy.

Vice-President Vitor Constancio said on Tuesday "everything is possible'' and both he and Praet have said asset buying - or quantitative easing (QE) - is an option after years in which the bank's policymakers have ruled it out.

But the more conservative minority at the bank, who voted against this month's surprise cut in interest rates and are led by its German members, still seem dead set against any such move.

(Read more: ECB, urged by OECD to buy assets, says all options on the table)

President Mario Draghi on Thursday played down the idea of moving deposit rates into negative territory while on Friday he separately stressed the need to keep interest rates low.

''I understand the concerns about a prolonged period of low returns on savings. But it is important to understand that interest rates are low because the economy is weak,'' Draghi told the European Banking Congress in Frankfurt.

"If we raised rates, we would further depress the economy, people would lose their jobs, and then their savings would be lower for longer.''

(Read more: ECB's Draghi: Nothing new on negative deposit rates)

Praet, who sits on the ECB's six-strong Executive Board, said the financial crisis had saddled the euro zone with a debt burden unique in Europe's post-war history because it has created a more deflationary environment.

"This is a very different context for the correction of expectations (about income), which is more of a debt overhang,'' he told a conference at the Bank of France.

"It has more signs of a balance-sheet recession, which is a priori more of a deflationary environment than what we had in the 1960s,'' added Praet, who is in charge of the ECB's economics portfolio.

Money printing

On Thursday, Draghi poured cold water on a media report that the ECB was actively considering taking its deposit rate - now at zero - into negative territory, a move that would see it effectively charge banks to hold their money overnight.

The OECD threw its weight behind the QE idea this week but, in a telling sign of the fierce resistance such an option would face from ECB hawks, Bundesbankchief Jens Weidmann said printing money is not the way out of the euro zone crisis.

Weidmann regularly stresses the limits of monetary policy and German finance minister Wolfgang Schaeuble weighed in behind him this week.

At any rate, before resorting to a measure like QE - one of the most divisive policy options on the 23-man Governing Council - the ECB is more likely to conduct another long-term liquidity injection, or LTRO.

(Read more: ECB split rate decision does not mark major policy divide)

The ECB funnelled over one trillion euros in 3-year loans to banks in late 2011 and early 2012 at an interest rate tied to its main refinancing rate, now at 0.25 percent.

A Reuters poll of money market traders earlier this month showed most expected the ECB to conduct another LTRO, probably in the first quarter of next year.

But even an LTRO could meet resistance from some Council members. Weidmann said on Thursday the ECB must ensure its lending operations do not become too generous.

Austria's Ewald Nowotny said in Paris on Friday that interest rates at current historic lows ``cannot be seen as a long-term equilibrium.''

But he added:`"What if we ... are approaching a period of long-term stagnation? In this case of course there could not be any idea of having higher interest rates in the foreseeable future.''

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