Draghi says ECB ‘comfortable’ with acting to fight low inflation, rising euro

European Central Bank president Mario Draghi surprised the markets by saying the bank's governing council is "comfortable" in launching measures next month to fight falling inflation and the rising euro, a strong signal that the ECB thinks the euro zone recovery is in jeopardy if no action is taken.

While the ECB, as expected, left the benchmark interest rate intact at a record low of 0.25 per cent, Mr. Draghi repeatedly highlighted the dangers of falling inflation and the rising euro. In his press conference, he said: "The strengthening of the exchange rate in the context of low inflation is cause for serious concern in the view of the governing council."

But Mr. Draghi did not say which easing measures the ECB is prepared to take to tackle disinflation and the rising euro. Options include forms of quantitative easing tailored to the European markets, negative interest rates (charging banks to park funds at the ECB) or a cut that would take rates to zero. The ECB could also intervene in the foreign exchange markets to put downward pressure on the euro.

The euro has climbed about 10 per cent since mid-2012, making imports cheaper, which puts downward pressure on inflation rates, and exports more expensive, which damages the economic growth that the 18-country euro zone so desperately needs. While only one country – Cyprus – is still officially in recession, the recovery elsewhere is so weak that it is barely putting a dent in the region's double-digit unemployment rate.

Before the ECB's mid-afternoon press conference in Frankfurt, the euro rose well above $1.39 (U.S.) and seemed on the verge of charging towards $1.40. But after Mr. Draghi said he was "comfortable" with taking action, the currency reversed course, trading in the late afternoon at $1.388 (U.S.). Euro bonds and equities rallied.

While Mr. Draghi did not commit to taking easing measures at the June governing council meeting, his strong concerns about falling inflation and the strong euro suggest the ECB is unlikely to sit on its hands again. Euro zone inflation was last measured, in April, at 0.7 per cent and has been as low as 0.5 per cent in recent months. The ECB's target rate is close to 2 per cent.

The rising euro and falling inflation have rattled some euro zone governments.

France has been putting pressure on the ECB to take action for fear that the strong euro will damage its export markets. On Wednesday, French economy minister Arnaud Montebourg said he believed the ECB had taken on board "a certain number of concerns that we have expressed recently."

The bank, however, defends its independence fiercely and is theoretically immune to lobbying efforts. "We have received plenty of advice from politicians on everything and we are certainly thankful for this advice," he said, somewhat sarcastically. "People should be aware that if [comments like this] were seen as a threat to our independence, that could do long-term damage to our credibility."

Earlier this week, the Organization for Economic Co-operation and Development (OECD) called for the ECB to move inflation to its 2-per-cent target level and "be ready for additional non-conventional stimulus," such as quantitative easing.

Working somewhat against the chance of easing measures is the broadening, though painfully slow, improvement in the euro zone economy. In Portgual, one of the euro zone's three bailed out countries, the jobless rate fell two full percentage points last year. Greece, the hardest hit country in the region, is issuing debt for the first time since its 2010 bailout. The other stand-out weaklings, Spain and Ireland, are also on the mend. "You see in all four countries clear signs of recovery," Mr. Draghi said.

Mr. Draghi's comments about being ready and comfortable to launch easing measures will make it hard for him not to take action, some economics and strategists said. "If the ECB sits on its hands next month, its credibility, which has already been undermined by its tolerance of near deflation in the euro zone, will suffer further," Nicholas Spiro, managing director of London's Spiro Sovereign Strategy said in a note. "Unfortunately, even if the ECB does take action, it's almost certain to be a case of too little, too late."