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Slowing inflation puts ECB in hot seat again

[NAPLES] Persistent and dangerously low eurozone inflation will keep the heat on the European Central Bank headed by Mario Draghi to inject more stimulus at its monthly policy meeting on Thursday, analysts said.

But despite this pressure, and in view of a surprise rate cut last month, the ECB is not expected to announce any new policy moves.

This meeting is being held in Naples, Italy, instead of at the bank's headquarters in Frankfurt as usual.

Mr Draghi is Italian and it was largely as governor of the central bank there that he earned the name "super Mario" for his negotiating and communication skills, a reputation borne out by a number of big and controversial policy initiatives by the ECB under his presidency.

"There is little prospect of any major new measures," said Ben May of Oxford Economics.

However, financial markets are looking for more details from ECB president Mario Draghi about the bank's contested liquidity programmes.

They are waiting particularly for information about its plans to buy asset-backed securities (ABS) and covered bonds as a way of kick-starting lending in the 18 countries that share the euro.

And some ECB watchers will also be listening out for any hints that the bank may embark on a much wider programme of so-called quantitative easing (QE) or the purchase of unlimited amounts of bonds, a policy already practised by other central banks such as the US Federal Reserve and the Bank of England.

According to new data this week, eurozone inflation slowed to 0.3 per cent, the lowest level for nearly five years, in September.

That, together with weak eurozone manufacturing data on Wednesday, has turned up the pressure on the ECB to take even more action to avert the threat of deflation - a vicious downward spiral of falling prices and demand which central banks have great difficulty reversing.

"No matter what the ECB tries, the eurozone economy is not really reacting and instead continues to flirt with stagnation," said ING DiBa economist Carsten Brzeski.

"As a consequence, speculation about further monetary policy action has again increased," Brzeski said.

But he, too, believed that following last month's raft of measures, "we only expect the ECB to announce the details of the ABS/covered bond purchasing programme," he said.

Asset-backed securities (ABS) are bundles of individual loans such as mortgages, auto credit and credit-card debt which are sold on to investors, allowing banks to share the risk of default and freeing up funds to offer more credit.

The ECB believes that the market for such securities - an important source of financing for banks to keep lending to small and medium-sized enterprises - has effectively dried up since the financial crisis.

And the ECB hopes that by buying them on a large scale, it can help revive the market and free up some of the credit channels which have seized up during the long years of crisis.

The problem is that it was precisely complex financial derivatives such as ABS which are seen as the root of the sub-prime crisis in the US in 2008, leading many observers, particularly in Germany, to harbour deep reservations about them.

Some analysts are also unconvinced that the ABS programme would be big enough to solve the problem of depressed credit activity.

But Richard Barwell at RSB said such reservations missed the point.

"The creation of the scheme should encourage issuance, expanding the pool from which the ECB can buy ('build it and they will come')," Mr Barwell argued.

UniCredit economist Marco Valli estimated the initial amount of any ABS programme at 550-650 billion euros.

Another of the ECB's liquidity measures, the so-called Targeted Long-Term Refinancing Operation (TLTRO) under which the central bank made ultra-cheap loans available to banks in the hope that they would lend it on to businesses, disappointed market expectations.

The ECB said it lent 82.6 billion euros (US$105 billion) to 255 banks as it began the programme, below analysts' forecasts for an uptake of at least 100 billion euros.

Mr Valli at UniCredit suggested that the low uptake was attributable to banks getting their balance sheets in order for the eurozone asset quality review and eurozone stress tests.

"It looks like banks in core countries will tap the facility predominantly in December," he said.

The euro has dropped sharply against the dollar since the last measures were announced and while the ECB insists it has no exchange rate target, that is likely to come as some relief to the central bank, analysts said.

"The fall reduces the tail risk of deflation further," said Mr May at Oxford Economics. - AFP