Low inflation to linger for years in euro zone

By Sumanta Dey

(Reuters) - The euro zone is set for at least two more years of low inflation, held down by a strong currency and anemic economic and jobs growth, and still faces a very real threat of deflation, a Reuters poll showed on Wednesday.

While the inflation forecasts are mostly in line with the European Central Bank's predictions, they show the difficulty the bank will have in reversing the trend of falling inflation given that its key interest rates are already at or near zero.

Euro zone inflation has slipped steadily in recent months, falling to 0.5 percent in March, the lowest since November 2009 and about a quarter of the ECB's preferred target of below but close to 2 percent.

While that is part of a global trend of disinflation, many observers including the International Monetary Fund are concerned that deflation - which has weighed on Japan for most of a generation - is a significant threat.

The poll of 61 economists conducted April 9-15 showed inflation averaging 0.9 percent this quarter as well as this year, picking up to 1.3 percent next year. The ECB is not expecting it to rise back to target until late 2016.

What the ECB has not been very vocal about until very recently is how much the strong single currency has been getting in the way of its goals by the downward pressure it puts on the price of imports.

"The ECB has probably been a little complacent about the strength of the euro and its disinflationary effect," said Jonathan Loynes, economist at Capital Economics.

"It's still forecasting inflation to rise towards its target by the end of next year and beyond, but the reality is that we have deflation in some of the peripheral economies."

Prices have already begun falling on an annual basis in Greece and even in Spain, the euro zone's fourth-largest economy. Worryingly, this is happening even as these economies are starting to show signs of reviving.

Japanese Finance Minister Taro Aso on Saturday urged the ECB to monitor inflation closely and to ease policy aggressively if prices go steadily negative, citing Japan's experience with years of falling prices.

At the same time, the euro has remained firm, after rallying 4 percent in 2013 and shows no signs of weakening, even though foreign exchange strategists polled earlier this month are nearly all forecasting it will fall soon. <EUR/POLL>

The latest Reuters poll found euro zone growth is expected to average just 1.1 percent this year and 1.4 percent next year, unchanged from the last poll, and not enough to make any significant dent in high unemployment or generate higher wages or prices in the economy.

The ECB has signaled that it is seriously considering quantitative easing, a policy that both the Federal Reserve and Bank of England opted for half a decade ago and have wound down or are in the process of doing so.

But economists are not convinced the ECB will ever take such a step. Even if it did, forecasters are not sure how it would be conducted. Most agree that the ECB is unlikely to opt for outright buying of government bonds as the Fed and BoE did - and as the Bank of Japan is still doing.

The IMF said on Friday the ECB should expand its balance sheet further to stave off the risk of deflation and not just limit the program to government bond-buying.

The ECB has made clear it is keen to cut what it has left from its refinancing rate, at a record low of 0.25 percent, or the deposit rate to below zero, beforehand.

Yet the consensus in the poll showed the central bank is not likely to do either over at least the next 18 months. Only eight expect it will cut rates by mid-year.

Forecasters in recent Reuters Polls have said the ECB has other options on the table too, including halting the steps that offset the effect of its previous bond buys under the Securities Markets Programme (SMP) or another wave of cheap cash loans to banks, known as long-term refinancing operations (LTROs).

"The ECB will cut interest rates in June, will lower the deposit rate into negative territory and also act on the liquidity window as well as suspending sterilization of the SMP," said Guillaume Menuet, economist at Citi.

(Additional reporting by Ishaan Gera and Deepti Govind in Bangalore; Polling by Sarmista Sen and Kailash Bhathija; Editing by Hugh Lawson)