The European Central Bank has further scope to cut euro zone interest rates, Governing Council member and head of the German Bundesbank, Axel Weber, said today.
"The ECB Governing Council has cut interest rates sharply to unprecedented levels," Mr Weber said in a text of a speech at a conference on central bank forecasting. "We still have room to cut interest rates further."
The ECB has cut interest rates at a record pace in recent months to an all-time low of 1.5 per cent and analysts expect it to cut them again to 1 percent at its next meeting on April 2nd.
Mr Weber also said it might be useful for the ECB to keep at hand instruments that enable it to reverse its monetary policy stance at the first signs of a financial sector recovery.
"It is essential to bear in mind that an expansionary monetary policy comes at the price of creating a breeding ground for future risks to price stability," he warned.
He added that risks to current euro zone economic forecasts should become more balanced.
On the upside, he said the recent flood of monetary and fiscal measures from central banks and governments might bolster confidence and growth. But on the downside, news about the health of the economy might continue to disappoint.
"There remains, of course, the risk that the economic downturn in the euro area might become more severe than the staff projections indicate," Mr Weber said, citing negative feedback effects from the financial turmoil.
"The degree of uncertainty about growth and inflation remains substantial at the moment."
Last month the ECB sharply revised down its outlook for the euro zone, predicted the economy could shrink as much as 3.2 per cent this year. Other top institutions have also been slashing forecasts on a regular basis as the financial turmoil and the recessionary aftermath has worsened.
Mr Weber said the way ECB staff projections are calculated was changed last autumn to try and account for shock and estimation uncertainty instead of uncertainty from previous forecast errors.
"Instead of deriving them from past forecast errors, these (staff forecast) ranges are now based on Bayesian Vector Autoregressions that account for shock and estimation uncertainty."
But he said that neither model was perfect and said ECB decision makers may supplement the forecast uncertainty with a qualitative assessment.
Reuters