The ECB has engaged in bond purchases in the past but has always withdrawn an equivalent amount of money from markets to ensure its interventions are neutral for the money supply, fearful of stoking inflationary pressures.

But with the ECB’s main interest rate now at 0.5 percent and euro zone inflation at 1.2 percent, St. Louis Federal Reserve Bank President James Bullard recommended the ECB could consider quantitative easing (QE), or printing money for asset purchases.

“For the euro area, which has not wanted to do QE, I would say this: if more monetary policy accommodation is desired, and it might be because inflation is running pretty low in the euro area, the Governing Council on the ECB may want to consider a GDP-weighted quantitative easing programme,” he said in a lecture at Frankfurt’s Goethe University.

With euro zone inflation undershooting the ECB’s target of just below 2 percent, the bank’s policymakers have discussed cutting the deposit rate they offer banks for holding their money overnight into negative territory from zero now.

Bullard said that when debating this option in the United States, his concern had been that “there are not enough basis points to have that big of an impact … the other concern is that it would somehow impact market functioning.”

He expected a similar debate in Europe.

Instead, he recommended the ECB pursue an asset purchase programme. He expected this could be as effective as that employed by the Fed, which is currently purchasing $85 billon worth of bonds every month.

“For the euro area, I think you might want to consider the GDP-weighted quantitative easing programme”, Bullard said, summing up his presentation.

Asked whether he was on a mission from the Fed to convince the ECB of a policy change, he said: “If you know me, I’m always trying to convince people about my own views and sometimes I win, sometimes I don’t. But no, I speak for myself and certainly not for the Committee.”

The ECB has mothballed its previous bond-buy plan, the Securities Markets programme (SMP), and has yet to activate its new plan – the Outright Monetary Transactions (OMT) policy.

However, the mere creation of the OMT has helped narrow yield spreads in the Spanish and Italian bond markets – which the ECB was thinking of when it created the program – following its launch in September 2012.

“If inflation slows further in Europe, the ECB governing council may wish to take actions beyond those, such as the OMT, that have been taken to mitigate the continent’s debt crisis,” said Bullard.

He also cited the Japan’s lost-decade of economic stagnation to reinforce his argument that just cutting interest rates was insufficient to ward off a damaging deflationary spiral.

“Doing nothing risks the mildly deflationary situation experienced by Japan in recent years,” he said.

(Reporting By Paul Carrel; Writing by Alister Bull; Editing by Neil Stempleman; editing by Ron Askew)

St. Louis Federal Reserve Bank President James Bullard, a
voting member of the Fed’s policy-setting committee this year,
also said the U.S. central bank should keep buying bonds, while
adjusting the pace of purchases up or down, according to
incoming economic data.

“Quantitative easing is closest to standard monetary policy,
involves clear action and has been effective,” Bullard said in
remarks prepared for an economics lecture at the Goethe
University in Frankfurt.

The Fed is currently purchasing $85 billon worth of bonds
every month. It next meets on June 18-19 to review policy and
there has been some speculation it might signal a readiness to
taper the program, although most economists think it will keep
buying bonds for the bulk of 2013, based on recent mixed data.

Bullard did not tip his hand on what to expect from the Fed,
but noted the U.S. recovery had been disappointing and inflation
was drifting lower in both the United States and Europe.

However, he was more prescriptive for the euro zone, noting
the common currency bloc had tipped back into recession, and
suggested the ECB think about following the Fed and Bank of
Japan in undertaking a similar asset purchase program.

“If more monetary policy accommodation is desired, consider
a GDP-weighted quantitative easing program,” he noted in a slide
presentation accompanying his lecture. GDP-weighting would make
up for the fact there is no pan-European government bond market
to appropriately distribute the benefits of the policy, he said.

“If inflation slows further in Europe, the ECB governing
council may wish to take actions beyond those, such as the OMT,
that have been taken to mitigate the continent’s debt crisis,”
said Bullard.

The ECB’s Outright Monetary Transactions policy to buy
government bonds of euro zone members has not yet been put to
use. But it has helped narrow yield spreads in the Spanish and
Italian bond markets – which the ECB was thinking of when it
created the program – following its launch in September 2012.

Bullard also cited the Japan’s lost-decade of economic
stagnation to reinforce his argument that just cutting interest
rates was insufficient to ward off a damaging deflationary
spiral.

“Doing nothing risks the mildly deflationary situation
experienced by Japan in recent years,” he said.

Economists said the rise was considerably weaker than they had expected, probably due to the currency bloc’s weak economy weighing on morale, but it still pointed in the right direction.

The Mannheim-based ZEW think tank said on Tuesday its monthly poll of economic sentiment rose to 36.4 points from 36.3 in April. It undershot the consensus forecast in a Reuters poll of 30 economists for a reading of 38.3 but the gain was a significant improvement on last month’s steep fall from 48.5.

“Recovery will set in the spring and then continue,” said ZEW economist Marcus Kappler. “The conditions for Germany to enter recovery are very good … Global conditions are good.”

The ZEW figures chimed with recent upbeat data showing exports, industrial orders and output all rising in March.

Lothar Hessler, an analyst at HSBC Trinkaus, said that data and the news of the European Central Bank cutting interest rates had led him to expect a better result for ZEW.

“The data nevertheless point to a stabilization of the German economy. It is growing again,” he said. “But the euro zone is still in a recessionary phase. That in turn dampens the upswing here.”

The German economy grew strongly during the early years of the euro zone crisis but it lost momentum last year, with weakness in foreign trade and a lack of investments driving it to a 0.6 percent contraction in the fourth quarter.

Most economists expect it to skirt a recession by growing moderately in the first three months of this year. Data on gross domestic product is due to be released on Wednesday and is expected to show GDP up 0.3 percent.

The economy has not yet featured prominently in Germany’s election campaign but if it worsens significantly it could become a headache for Chancellor Angela Merkel as she seeks a third term in office in September.

The ZEW data showed a separate gauge of current conditions dropping to 8.9 this month from 9.2 in April, well below the 10.0 consensus forecast.

The indices were based on a survey of 251 analysts and investors conducted between April 29 and May 13, ZEW said.

(Writing by Sarah Marsh, Editing by Gareth Jones)

Taking the deposit rate into negative territory would mean the ECB charging commercial banks for holding their money overnight, something ECB President Mario Draghi has said the central bank was “technically ready” to do.

Such a move could encourage banks to lend out money to the real economy rather than hold it at the ECB, though it could also have a big impact on banks’ own operations and major implications for funding and bond markets.

While non-euro zone member Denmark has dabbled with negative deposit rates, the ECB would be the first major central bank to use the measure – a policy step it is considering to try to boost lending to businesses in the recession-mired euro area.

Visco said the ECB was ready to deal with possible unintended consequences of negative deposit rates.

“We all agreed in the council that we have to look with care and in that case we may reduce the deposit rate,” Visco, a member of the ECB’s policymaking Governing Council, told CNBC in an interview.

“We think that – and I personally think that, this is effective – the economy now is capable of taking it on board. Technically, we are equipped and ready to intervene. There may be unintended consequences – we know we may have to work on that – and we know how to work on that,” he was quoted as saying.

The euro fell against the dollar to $1.2953 after Visco’s comments from $1.2976 beforehand while the benchmark German 10-year government bond futures rose after the comments.

The ECB kept the deposit rate at zero at its policy meeting on May 2, when it cut the main refinancing rate to record low 0.5 percent.

After the rate decision, bank president Draghi said the ECB was “technically ready” to reduce the deposit rate into negative territory.

Economists in a Reuters poll taken last week doubted that the ECB would cut the deposit rate further, with only six out of 57 analysts saying it would take it below zero in the coming months.

In a separate interview with the Wall Street Journal, Visco said that central bank actions “can only be a part of the story” and urged governments to continue with structural reforms.

(Reporting by Sakari Suoninen and Eva Kuehnen; Editing by Toby Chopra)

These allow banks to move at least some credit risk off
their balance sheets by packaging individual loans into new
instruments and selling them on to other investors.

Credit markets were paralysed during the crisis when such
securities became toxic due to the default of housing loans that
underpinned them.

But the ECB is now considering whether such securities could
help the euro zone’s small- and medium-sized enterprises (SMEs),
the backbone of the bloc’s recession-hit economy, saying that
not all ABS are bad.

Issuing them could enable banks to boost their capital and
liquidity buffers to meet tougher post-crisis rules – one reason
for their current reluctance to lend – and extend more loans to
struggling SMEs which have few alternatives to bank funding.

At its Governing Council meeting in Bratislava on Thursday,
the ECB decided to start talks with the European Investment Bank
and the EU Commission to revive the ABS market after several ECB
board members had hinted that such a step was in the offing.

But turning to ABS could throw up more problems than it
solves and despite ECB-led efforts to revive the market it would
still not unblock lending to small companies in the euro zone’s
south without more far-reaching regulatory changes.

“Even if investors get comfortable with the risk profile of
an SME-loan portfolio, they may not have the resources to go in
and restructure the underlying companies if they fail,” said Tim
Skeet, managing director, financial institutions group at RBS.

“They could end up owning the companies and their assets.
There is a higher default level among SME loans compared with
other types of lending and this is of course reflected in the
capital charge imposed by the regulators,” said Skeet, also an
International Capital Market Association board member.

BREAKING NEW GROUND

In February, Commerzbank, which touts itself as a lender to
SMEs, tested the waters. Germany’s second-largest bank raised
500 million euros by placing a bond that was covered by a
portfolio of SME loans – the first of its kind.

“We found out through various conversations with investors
that there was an interest in the German SME market,” said
Franz-Josef Kaufmann, head of capital market funding at
Commerzbank. The deal ended up being two-times oversubscribed.

Although the issue was not strictly a covered bond because
the underlying assets were SME loans and not public-sector or
mortgage loans, when used as collateral at the ECB it will still
get the lower mark down that comes with such bonds.

Such an improvement in funding costs could be passed on to
borrowers and may entice others to follow suit.

The drawback in the Commerzbank case was that, unlike a
fully-fledged ABS, the loans did not leave its balance sheet.
Therefore it did little to minimise the bank’s capital costs.

“We have noticed that other banks are looking at this new
asset class, but you really need a critical mass of loans on
your books to make it worthwhile,” Kaufmann said.

TOO DIVERSE

JPMorgan calculated a volume of ABS based on SME loans in
the euro zone around 170 billion euros ($224 billion). Even if
the actual figure is higher, it remains small compared with
other asset classes.

The ECB could support issuance and raise the profile of the
asset class through targeted purchases, JPMorgan economist Greg
Fuzesi suggested. The ECB’s previous covered bond programmes
could serve as templates for such interventions.

Market-led initiatives providing quality stamps for ABS
along with increased transparency from the ECB’s new loan
database could drive demand.

But the diversity of small companies in terms of their
business models as well as ownership and funding structures
makes it hard to pin down credit risk. Rating agencies hardly
look at them.

“To solve the flow of funding to the SME sector, we probably
need a better capital regime for these loans. This is already
happening in the UK through the Funding for Lending Scheme and
we might see this in France in other piecemeal arrangements.”
RBS’s Skeet said.

Since the crisis, regulators have forced banks to hold more
capital against securitised debt and retain a “skin in the game”
portion to ensure high underwriting standards.

However, Britain’s financial regulator adjusting liquidity
and capital rules for British banks if they increase lending to
households and businesses.

($1 = 0.7585 euros)

(Reporting by Eva Kuehnen)

Economic data over the past weeks since ECB President Mario
Draghi said the bank stood ready to act if necessary has shown
growth prospects darkening.

Unemployment hit a record high in April. Inflation had its
biggest monthly drop more than four years, to 1.2 percent, well
below the banks target of 2 percent or slightly below.

“If the ECB does hold fire on interest rates next Thursday,
it is very likely only delaying the inevitable,” said Howard
Archer, European economist at IHS Global Insight.

ECB Vice-President Vitor Constancio last week said there was
still room to cut interest rates, reiterating the bank’s
readiness to act should the economy deteriorate further, which
he said had been unfortunately the case.

A Reuters poll of 76 economists taken last week – before the
inflation data – saw a slim majority forecasting a 25-basis
point cut from the current 0.75 percent, while only half of the
22 euro money market dealers polled by Reuters expect such a
step.

But the economic impact is questionable and not everybody is
in favour of another cut. German Chancellor Angela Merkel said
last week the ECB would have to raise interest rates if it were
looking at Germany alone.

German insurers and the county’s dominant savings and
cooperative banking sector have also joined up to speak out
against looser ECB monetary policy, saying it would have little
economic impact and undermined savings needed to protect the
country’s rapidly ageing population.

The euro zone periphery countries take the opposite view.

“Mr Draghi has been very good with words since the summer,
but now it is really time to deliver accommodative policy in the
periphery of the euro area,” said Anna Maria Grimaldi, European
economist at Italian bank Intesa Sanpaolo. She sees a potential
for the ECB to cut rates by 50 basis points on Thursday.

SMALL COMPANIES, BIG PROBLEM

The euro zone’s south is not benefiting to the same extent
as the north from ultra-low rates. Banks there are charging
companies and households more for loans than their peers in the
north because of higher funding costs and credit risks.

The ECB has repeatedly voiced its concern about the impact
this has on lending to small- and medium-sized enterprises
(SMEs), which have little alternative to bank funding and are a
key engine for growth in the currency bloc.

It has said it is studying options to address the problem,
but little is expected to be decided at Thursday’s policy
meeting that is taking place in Bratislava. It is one out of two
policy meetings the ECB holds outside of Frankfurt each year.

“We suspect that the ECB will avoid making any formal
statement on a potential SME programme … as it continues to
weigh the pros and cons of such measures,” said Frederik
Ducrozet, senior euro zone economist at Crédit Agricole CIB.

(Reporting by Eva Kuehnen, additional reporting Jonathan Gould.
Editing by Jeremy Gaunt.)

ECB Vice-President Vitor Constancio said inflation had fallen “rather significantly” and a rate cut was “always a possibility”, but Governing Council member Klaas Knot said the ECB had “little ammunition left” and should use it carefully.

The ECB left rates at a record low of 0.75 percent in April, but ECB President Mario Draghi said after its monthly policy meeting that the bank would “monitor very closely” all data and stand “ready to act” to boost the recession-hit euro zone.

But the bank believes another cut would have only limited impact because its ultra-low interest rates do not reach all economies in the currency bloc evenly, with lenders in crisis countries passing on higher funding costs to their consumers.

A rate cut would have symbolic importance, however, signaling that the ECB is ready to support the economy.

“It is a tactical decision,” said Frederik Ducrozet, senior euro zone economist at Crédit Agricole said. “It is a way to manage expectations.”

Annual euro zone inflation fell to 1.7 percent in March, its lowest level since August 2010, spurred by a continued downward trend in energy prices. The ECB expects inflation to fall further to average 1.3 percent next year.

Constancio said the fall in inflation was “an important factor of course for us, because inflation is always the first consideration”.

“At the same time, the economy continued to give signs of weakness, and that’s where we are. So when we have our next meeting we will see the latest information and we will take the decision,” Constancio told news agency MNI in an interview.

He added that a new rate cut was “always a possibility”.

His comments lifted German Bunds off their lows of the day as investors bet more heavily on a rate cut.

This week’s economic data releases include euro zone consumer confidence on Monday, the April reading of purchasing managers’ indices on Tuesday and the ECB’s bank lending survey on Wednesday, with PMIs especially being looked at carefully as they could make or break the chance of a rate cut.

The ECB Governing Council will meet in Bratislava on May 2.

“Unless we get a massive surge in the PMI reading tomorrow the case for a rate cut is gaining traction,” Crédit Agricole’s Ducrozet said. “Otherwise you risk disappointment.”

“LITTLE AMMUNITION LEFT”

ECB Governing Council member Klaas Knot, who is also the governor of the Dutch central bank, was quoted as saying by Bloomberg News over the weekend that the “last information we have on the economy isn’t that positive and isn’t leading to better prospects”.

“We have little ammunition left so we need to ask ourselves when is the right moment to use it,” he said.

His colleague on the Council, Slovenian Marko Kranjec, struck a more optimistic tone, saying if the rest of the world economy picked up, the euro zone would also be in good shape.

He also said he was not worried about inflation.

“It is a bit low, but still close to but below 2 percent. It is of course less than 2 percent, but this doesn’t worry me,” Kranjec told MNI in an interview, adding that it was “still consistent with price stability, it is not deflation”.

(Editing by Catherine Evans)

The Mannheim-based ZEW think tank said on Tuesday its
monthly poll of economic sentiment fell to 36.3 points from 48.5
in March. The reading undershot a Reuters poll forecast of 42.0
and sent the euro down against the dollar.

“There is increasing evidence that there are growth risks,”
ZEW President Clemens Fuest said.

“There has been some disappointing data coming from China,
from U.S. labour markets, from German exports. There have been
some doubts about the strength of the recovery and some people
think there is now confirmation of that.”

He pointed to a particularly strong decline in
export-related industries in Germany, such as the automotive
sector.

Long resilient to the euro zone crisis, Germany’s economy
slowed in 2012 and output shrank by 0.6 percent in the final
quarter. But economists expect it to avoid recession and to have
returned to weak growth in the first three months of this year.

Still, weak data in recent weeks has raised fears that
Europe’s powerhouse may be faltering. Imports and exports fell
sharply in February, and industrial output has been lacklustre.

A significant slowdown in Germany could be a headache for
conservative Angela Merkel who hopes to clinch a third term as
chancellor in an election in September.

“The chickens are coming home to roost for economic
confidence in Germany,” said David Brown of New View Economics.

“The problems are starting to pile up for business, with the
debt crisis in Cyprus, euro zone recession and slowdown in China
all taking a greater toll on sentiment,” he said, adding
confidence that German businesss could shrug off downside risks
was looking increasingly misplaced.

In addition, worries about the euro zone crisis have
resurfaced with the focus on Portugal, which is having to
rethink some austerity policies after a constitutional court
ruling and Cyprus, which is being bailed out after a messy
debate over how hard to hit depositors in its banks. Italy also
faces political uncertainty after an inconclusive election
result.

In what appeared to be a dig at the German government, Fuest
also said one underestimated risk factor was the debate about a
banking union in Europe.

“These decisions are routinely postponed,” Fuest said.
“These decisions do raise some doubts about the ability of the
periphery countries to address the weakness of their financial
sectors.”

Germany, backed by allies like Austria, has called for a
change in EU treaties to allow for a so-called banking union,
raising questions about how fast it can be implemented.

The ZEW index was based on a survey of 243 analysts and
investors conducted between April 2 and 15, ZEW said. The
institute said the indicator was hovering at its third highest
mark in the last two years, despite the April decline.

French business activity plummeted in March, putting the
brakes on the bloc’s recovery, as high unemployment weighed on
private consumption that accounts for more than half the French
economy.

The ECB noted at its April policy meeting that the economic
weakness had spread beyond the bloc’s crisis-stricken periphery
while the transmission of interest rates across the bloc had
improved, a change in tone from previous assessments.

In February, French central bank governor Christian Noyer
had dismissed talk of a rate cut, saying there was no interest
at the ECB in cutting rates if it only impacted Germany or other
core countries.

Last week, ECB President Mario Draghi said the bank would
“monitor very closely” all data and stood “ready to act”.

Draghi’s remarks, and comments from French ECB policymaker
Benoit Coeure, who said inflation appeared set to move further
below the ECB’s target, have fuelled expectations that a rate
cut is possible.

“A rate cut sooner rather than later has become increasingly
more likely given the somewhat weaker-than-expected production
and export performance at the start of the year, in particular
in the euro area’s core,” said Daiwa economist Tobias Blattner.

The ECB has limited room for manoeuvre.

Its main rate is a record low 0.75 percent, the highest
level among the world’s major central banks. The deposit rate it
pays banks for holding their funds overnight is at zero and the
ECB is loath to cut it for fear of jolting the banking system.

Reluctant to cut this rate, which sets a floor for money
markets, the ECB has little ability to steer interbank rates -
and by extension little sway over the cost of borrowing for
firms and households.

Alternative policy options include ‘non-standard’ measures,
such as the provision of liquidity through lending operations.

“A rate cut would unavoidably fuel expectations about
further non-standard measures or more explicit forward
guidance,” Blattner said.

MALAISE HOLLANDAISE

A quarter-percentage-point cut in the main refinancing rate
would still have a marginal impact on France.

Its banks account for about 15 percent of the overall use of
ECB liquidity and the rates they charge for loans to companies
seem to reflect the record-low ECB rate. Until recently, French
corporate loan rates were even lower than those in Germany.

But France’s problems lie elsewhere.

France is on the brink of slipping into its third recession
since the 2008-2009 financial crisis as President Francois
Hollande’s Socialist government struggles to rein in a public
deficit and make French companies more competitive.

Between 2003 and last year, France’s exports rose about 40
percent while Germany’s rose twice as fast. And while hourly
wages in France rose 25 percent over the eight years preceding
the financial crisis, Germany’s grew at under half that pace.

To catch up, France is implementing radical labour market
reforms which aim, for example, to give firms more flexibility
to adjust headcount in downturns.

But unemployment is already at 10.6 percent, the highest in
more than a decade, and consumers’ reluctance to spend has among
other things driven down inflation – to 1.2 percent in February,
the lowest annual rate in more than three years.

Joerg Asmussen, an ECB policymaker and former German deputy
finance minister, on Tuesday stressed the importance of France’s
economic revival. “We all have a interest in an economically
strong France,” said Asmussen.

France is Germany’s largest export market. After Germany, it
is also the second-largest contributor to the euro zone’s ESM
rescue fund. France has already been stripped of its triple-A
status by two top credit rating agencies and further downgrades
could follow if France fails to get its deficit under control.

“The current problems go beyond a rate cut though it would
not do any harm,” said Fabrice Montagne, economist at Barclays.

TAKING ACTION

So far, the ECB has been tolerating slowing inflation as
euro zone countries adjust, but if the downturn persists, the
ECB may have to act. Anything beyond cutting the main
refinancing rate may prove more difficult to agree, however.

The ECB has already committed to provide unlimited liquidity
for as long as needed. Other forms of forward guidance, for
example on interest rates, could be an option even if it is
unlikely to be as explicit as the Federal Reserve’s pledge to
keep rates near zero until unemployment drops to 6.5 percent.

Some economists have said the ECB should start buying
bundled-up corporate loans to address the key problem of weak
lending to small- and medium-sized enterprises, crucial players
in the euro zone economy that rely strongly on bank funding.

Draghi said the ECB is “thinking about these issues from a
360-degree perspective”, but Bundesbank President Jens Weidmann
has already said he thinks national governments should step up.

“The problem is that the ECB doesn’t want to be the only one
to act,” said Gilles Moec, economist at Deutsche Bank in London.
“You need at least some strong commitments from governments
before the ECB can do something.”

(Additional reporting by Paul Carrel and Sakari Suoninen in
Frankfurt and Leigh Thomas in Paris; Editing by Catherine Evans)

Speaking at news conference after the ECB held rates at a
record low 0.75 percent, the highest level among the world’s
major central banks, Draghi said discussion at the monthly
meeting had been extensive and the consensus was to hold fire.

But he added that the ECB was studying the economic climate
closely because there was no certainty the euro zone economy
would pick up.

“In the coming weeks, we will monitor very closely all the
incoming information on economic and monetary developments, and
assess the impact on the outlook for price stability,” he said.

Draghi’s predecessor, Jean-Claude Trichet, used a stock of
coded phrases to signal future policy actions something his
successor has not previously indulged in. One of those phrases
was “monitor very closely” although in the Frenchman’s era it
more often presaged an interest rate rise two months’ hence.

Draghi also opened the way for the ECB to take fresh
‘non-standard measures’ – steps other than classic rate moves,
such as government bond purchases or funding operations like the
twin 3-year loans it offered banks just over a year ago.

“We are considering both standard and non-standard measures
and we are thinking 360 degrees on the non-standard measures,”
he said.

German government bond and euro zone interest rate futures
extended gains with market participants saying Draghi’s comments
laid the ground for a rate cut in coming months.

“In a nutshell, a rate cut or additional non-standard
measures cannot be ruled out in May,” said Annalisa Piazza at
Newedge Strategy.

The ECB is mandated to deliver inflation just below 2
percent. In March, it fell to 1.7 percent.
Draghi said inflation was “edging down, well below 2 percent”.

A survey released earlier on Thursday showed the euro zone’s
economic decline dragged on unabated in March, marked by a huge
drop in French business activity that outstripped even the
downturns in Spain and Italy.

“Weak economic activity has extended into the early part of
the year and a gradual recovery is projected for the second half
of the year subject to downside risks,” Draghi said.

As the world recovers from the financial crisis, the ECB has
lent less support to the economy than its peers in Japan, the
United States and Britain, which have launched massive asset
purchase programmes with new money and cut rates closer to zero.

ECLIPSED BY JAPAN

The Bank of Japan went a step further on Thursday. Its new
governor, Haruhiko Kuroda, shocked markets with a radical
overhaul of its policymaking, adopting a new balance sheet
target and pledging to double its government bond holdings in
two years as it seeks to end nearly two decades of deflation.

Japan is intent on pushing inflation higher, lifting the
country out of decades of deflation and minimal growth. The
scope of the changes drove the yen lower and knocked the 10-year
bond yield to its lowest in a decade.

A number of countries, particularly emerging economies, have
already complained about policies which drive currencies lower,
threatening a destabilising race to the bottom.

The ECB is unlikely to pursue a similar path, although a
stronger euro is the last thing a recession-mired economy
requires.

“Our exchange rate is not a policy target. Our exchange rate
is important for growth and price stability,” Draghi said.

German Finance Minister Wolfgang Schaeuble said Tokyo could
not count on central bank actions alone to boost its economy and
must carry through with structural reforms.

Earlier this week, ECB Executive Board member Benoit Coeure
warned against countries directly pursuing competitive
devaluations, especially if other central banks had limited room
for manoeuvre.

After early signs of stabilisation in the euro zone economy
at the start of the year, March marked a set back as Cyprus
narrowly escaped a financial meltdown by securing a last-minute
bailout and Italy struggled to end a post-election deadlock.

Euro zone economic sentiment fell after four months of gains
and surveys showed manufacturing across the bloc fell deeper
into decline.

The ECB is worried that its low rates are not reaching
households and firms in the euro zone periphery, mainly because
banks’ funding costs in crisis stricken countries are higher
than those in the core countries, pushing up loan costs.

This affects small and medium-sized enterprises (SMEs) in
particular as they have few alternatives to bank funding.

However, Draghi stressed that the ECB’s mandate constrained
its capacity to help its low interest rates reach SMEs. He said
the bank was looking at ways to help, but added that governments
and the European Investment Bank could play a role.

The Italian ECB chief also stressed that the Cyprus bailout
- involving losses imposed on richer bank depositors – was not a
template for future rescues as others have suggested.