Flickering signs of a recovery may be visible in the euro zone, but Christine Lagarde, the managing director of the International Monetary Fund, has called for more monetary easing by the European Central Bank (ECB) to combat falling inflation.
Speaking in Washington on Wednesday at the Johns Hopkins School of Advanced International Studies, Lagarde said there was an emerging risk of what she called "low-flation," particularly in the euro area.
"A potentially prolonged period of low inflation can suppress demand and output—and suppress growth and jobs. More monetary easing, including through unconventional measures, is needed in the euro area to raise the prospects of achieving the ECB's price stability objective," she said.
Investors will be focused on events in Frankfurt Thursday where the Governing Council of the ECB meets; most market watchers are not expecting a cut to its main interest rate.
Eighteen out of 22 money market traders polled by Reuters this week forecast no change in policy, which echoed the results of a larger Reuters poll of economists last week. This comes despite the consumer price index this week showing inflation had slipped to 0.5 percent in the euro zone.
This disinflation – where growth in consumer prices starts to weaken – has economists concerned that it could lead to deflation, when consumer prices actually fall. Deflation can push down demand, as people hold off purchases in the hope of more price declines. This can lead to lower production and an economic slump.
Lagarde is one of the most high-profile advocates of further stimulus by the ECB, with speculation that the central bank could decide to launch U.S.-style quantitative easing. The introduction of a negative deposit rate has also been touted. This would effectively charge banks to hold deposits at the ECB in the hope that the cash would find its way into the real economy.
Lagarde said on Wednesday that the world was at a critical juncture and emerging from the greatest financial crisis in almost a hundred years.
"Recovery is taking hold but is too slow and it faces several obstacles along the road. Bold policy steps can overcome these obstacles and take the global economy to the next level of more rapid and sustainable growth," she said.
Despite her warning, she said that there were positive changes in Europe with a modest recovery taking hold, albeit uneven with countries in southern Europe still showing weakness.
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"Encouraging steps have been taken recently to establish a banking union—which the IMF has been urging for some time. Implementing a common fiscal backstop remains key, as is the upcoming asset quality review of banks," she added.