ECB will provide stimulus until sustained inflation rebound

By Padraic Halpin and Francesco Canepa

LONDON/FRANKFURT (Reuters) - The European Central Bank will provide stimulus until a sustained inflation rebound, even as its unprecedented measures come with side effects and face constraints, two policymakers said on Friday, just as the bank is contemplating more easing.

Facing stubbornly low inflation, the ECB will decide in December whether to extend its 80 billion euro (£71.90 billion) per month asset buys beyond its scheduled end next March, having to balance diminishing costs with increasing side effects.

Arguing that the ECB's measures are working, Board Member Benoit Coeure also warned bank's margin of operation was reduced as rates approach their effective limits, so governments had to start pulling their weight to revive the euro zone economy.

"Postponing the necessary reforms is not a valid option anymore," Coeure told a conference in Frankfurt. "Procrastination and forbearance have not served the euro area well ... If our banks had been cleaned up and strengthened early after the crisis, our growth path would today be higher."

A key concern for the ECB is that negative interest rates depress bank margins, lower bank share price and increase the cost of capital. This could in turn reduce lending to the economy, countering the very stimulus the ECB is hoping to achieve.

Echoing many of Coeure's concerns, Governing Council member Philip Lane said the bank was "pretty happy" with the accommodation provided so far and did not see serious signs of the negative side effects.

"Until inflation is at a sustainable path to the current target, the current policy of accommodation will continue," Lane, the Irish central bank governor, said at a Reuters Newsmaker event in London.

INFLATION TARGET

Inflation has missed the ECB's 2 percent target for three and a half years and is expect to undershoot until late 2018 at the earliest, raising fears that businesses and households will lose confidence in the bank's ability to meet its mandate.

Both Coeure and Lane said that December would be the time to decide on the future of the ECB's asset buys, seemingly playing down a string of mildly positive data in recent weeks, arguing that the ECB wants to see a sustained rebound in inflation.

Markets price in an extension and sources close to talks said such an extension is very likely.

Coeure said that while the bottom for rates, where households and businesses switch to cash, is still below the ECB's minus 0.4 percent deposit rate, there is also an economic lower bound, where the negative impacts from weakened monetary transmission outweigh the benefits.

Still, Coeure also dismissed any suggestion the ECB was about to give up, arguing that missing the bank's 2 percent inflation target too often could lead to permanently lower inflation, a hard to break cycle.

"Monetary support for the recovery will continue until inflation is sustainably adjusting to our objective," he said. "Although our objective is forward looking, there is a risk that continued undershooting of our inflation aim will cause households and firms to revise down their inflation expectations."

"And lower inflation expectations directly lower the equilibrium nominal interest rate, requiring a lower interest rate to create monetary stimulus," he said.

(Writing by Balazs Koranyi; Additional reporting by John Geddie and Marc Jones; Editing by Alison Williams)