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ECB may roll out heavy artillery against deflation in 2015

[FRANKFURT] After a breathless year of action and now a new political crisis in Greece, the European Central Bank may finally roll out its heavy artillery in 2015 in its battle against deflation, analysts said.

Bank watchers say new elections due in January in debt-mired Greece may prove unsettling for European partners but should remain manageable for the eurozone as a whole.

This will mean the ECB's overriding challenge in the new year will continue to be to prevent the single currency area from sliding into deflation, a dangerous downward spiral of falling prices.

"I see a broad consensus around the table in the governing council that we need to do more," ECB executive board member Benoit Coeure said recently.

So far, the ECB has rolled out a wide range of measures to try and get eurozone inflation back up to the level of 2.0 per cent that it regards as economically healthy.

It has cut its interest rates to new all-time lows, made unprecedented amounts of cheap loans available to banks via its LTRO and TLTRO programmes, and embarked on asset purchase programmes (ABSs and covered bonds) to pump liquidity into the financial system.

But at 0.3 per cent, area-wide inflation is still alarmingly low and could even fall further as a result of falling oil prices.

So the ECB is currently examining the possibility of so-called "quantitative easing" or "QE".

This is the large-scale purchase of sovereign debt, a policy hitherto pursued by other central banks around the world to kick-start their moribund economies, but which the ECB has so far shied away from.

In Europe, critics of QE - not least the mighty German central bank or Bundesbank - see it as a licence to print money to get governments out of debt, which the ECB is strictly forbidden from doing under its statutes.

Nevertheless, most observers believe the question is not "if" but "when" such a programme will be on the cards, possibly as early as January 22 or the subsequent meeting on March 5.

Bundesbank president Jens Weidmann is an outspoken opponent of QE, which he argues would take the ECB way out of its current legal remit.

In a newspaper interview at the weekend, Weidmann warned against seeing QE as a panacea for the eurozone's ills.

"Disappointment is inevitable. And the real nature of the problems risks getting lost from sight," he told the Sunday newspaper Frankfurter Allgemeine Sonntagszeitung.

German Finance Minister Wolfgang Schaeuble agreed, arguing that "cheap money should not be allowed to dent the reform zeal in some countries. There is no alternative to structural reforms - if things are going to improve again." But ECB chief Mario Draghi insisted in December that "we don't need unanimity" on the governing council and a programme of QE could be designed in such a way to win consensus.

Commerzbank economist Michael Schubert said Draghi and his supporters had their work cut out for them in convincing the governing council to support QE.

Nevertheless, some analysts believe that while large-scale bond purchases may have worked for the United States and Britain, the different economic and legal set-up in the eurozone meant that QE would not be the cure-all that many hope it will be.

"It is important to note that the sovereign bond purchase programme as a stand-alone is unlikely to have the dimensions of the US, British, or let alone Japanese programmes," said Berenberg Bank economist Christian Schulz.

UniCredit economist Erik Nielsen warned that too much was being expected of the ECB, which has repeatedly taken on the role of firefighter in the long years of the eurozone crisis while politicians have been reluctant to push through tough but unpopular structural measures.

The new crisis in Greece, where a radical anti-austerity party looks set to win snap elections and possibly undo many economic reforms, would likely remain manageable for the eurozone as a whole, analysts said.

"Europe has built up its defences against contagion risks with the (European Stability Mechanism) support funds and the readiness of the ECB to do what it takes to keep all reform countries in the euro," said Berenberg Bank economist Holger Schmieding.

"A tragedy for Greece would probably not turn into a systemic crisis for the eurozone as a whole," he insisted.