By Martin Santa
BRUSSELS (Reuters) - The European Central Bank should cut its main interest rate to zero and keep it there for at least 18 months to counter persistently low inflation, the Organisation for Economic Cooperation and Development said on Tuesday.
Annual inflation in the euro zone was 0.7 percent in April, far under the ECB's medium-term target of below but close to 2 percent, and the ECB expects price pressures to stay low for a long time.
"Very low underlying inflation and large economic slack are expected to persist for several quarters," the OECD said in its twice-yearly economic outlook for the 18-nation currency bloc.
"Accordingly, the main refinancing policy rate should be reduced to zero, and possibly the deposit rate to a slightly negative level, and they should be maintained at these levels at least until end-2015."
The Paris-based organization published its report two days before a monetary policy meeting at which the ECB is widely expected to hold its main refinancing rate at 0.25 percent.
The OECD said a cut in borrowing costs together with recent improvements in financial markets should contribute to lower overnight interbank rates and ultimately lower bank lending rates, helping to stimulate growth and reverse disinflationary pressures.
The ECB would need to implement additional non-conventional monetary measures "if inflation did not show clear signs of returning toward the ECB target or ... if a deflationary scenario threatened to occur," the OECD's report said.
It said this could include terminating sterilization of the ECB's Securities Markets Programme and providing financing via new Long-Term Refinancing Operations, possibly at constant near-zero policy rates.
"Purchases of government or corporate bonds, or programs to foster bank lending to the non-financial private sector, could also be envisaged," the OECD said.
ECB President Mario Draghi gave his clearest indication yet in late April that the ECB could print money to buy assets if inflation slows, and identified further strength in the euro as a potential trigger for action.
But inflation perked up in April from the March low of 0.5 percent, and economists expect the ECB to wait for new economic forecasts from its staff in June before deciding whether to embark on either conventional or non-conventional policy easing.
The OECD forecast euro zone consumer inflation would fall to 0.7 percent this year from 1.3 percent in 2013 before accelerating to 1.1 percent in 2015.
The European Commission cut its inflation outlook on Monday for this and the next year, but said the risk of deflation in the 9.5 trillion economy was very low.
The OECD said euro zone's recovery was gradually picking up and forecast 1.2 percent economic growth this year and 1.7 percent in 2015 -- matching the European Commission forecasts.
"Economic activity will continue to pick up in 2014 and 2015, as confidence improves further, financial market fragmentation declines and fiscal consolidation ease," OECD said.
(Reporting by Martin Santa and Jan Strupczewski; Editing by John Stonestreet)