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Frankfurt - The European Central Bank is likely to keep the door open for more monetary stimulus but stop short of taking new policy steps at a meeting on Thursday as it awaits fresh indications about the outlook for eurozone inflation.
Consumer prices in the 19-country eurozone fell by 0.1% in September, prompting calls for the ECB to expand or extend its €60bn a month of asset purchases. The programme was launched in March to help push inflation back to the ECB's target of just under 2%.
While stressing their readiness to act, the bank's policymakers have said the fall in prices is largely due to energy costs, which the ECB cannot influence, and that it is unclear whether a slowdown in emerging economies will have a lasting impact on the eurozone.
Many also hope a fading of the base effect from 2014's oil price plunge will help push inflation higher by year-end.
Their cautious tone suggests the ECB will wait until it gets new inflation forecasts from its staff in December before deciding on any change to its quantitative easing scheme.
A broader debate meanwhile appears to be taking shape within the bank about whether monetary policy is already coming up against the limits of its effectiveness.
"We think the ECB will signal that it stands ready to act if needed, and that the door is open for further easing but more likely at the December or January meetings," economists at JP Morgan said in a note to clients.
Euro zone economic growth is slowing again, with even powerhouse Germany seeing a recent string of poor data, and one of the ECB's favoured gauges of inflation expectations, the five-year, five-year euro zone break even forward, has fallen to 1.7% from 1.85% in July.
Lending surveys have continued to improve, however, providing some ammunition for ECB President Mario Draghi to argue that QE is finding its way into the real economy and does not urgently need to be adjusted.
Draghi has said the ECB is prepared to intervene if risks to inflation increase or financing conditions tighten, and has cited the exchange rate as a key factor for price stability.
The single currency has strengthened since the last ECB meeting in early September, due in part to the Federal Reserve's decision to postpone its first post-crisis rate hike, and is currently trading at 1.13 against the greenback.
"It seems that a euro/dollar at 1.15 to 1.20 may represent a sort of 'pain threshold'," said Marco Valli, chief eurozone economist at UniCredit Research. "This implies that dovish rhetoric is very likely to continue and, possibly, intensify this week”.
The dollar edged slightly down against the euro and eurozone bond yields were steady ahead of the ECB's rate decision (11:45 GMT) and Draghi's news conference (12:30 GMT).
Thursday's meeting, which takes place in Valletta, will be the last for two policymakers, Ireland's Patrick Honohan and Christian Noyer of France, who are stepping down.
Scope to do more
ECB Vice President Vitor Constancio recently said there would be scope for the ECB to ramp up QE, as its programme is smaller relative to the size of the eurozone economy than those launched by the Fed, the Bank of Japan and the Bank of England.
The median probability of the ECB extending QE beyond its current September 2016 end-date stood at 70% in a recent Reuter’s poll of economists. The same poll saw a 40% chance of increased monthly purchases over the next six months.
Yet analysts have warned that upping the pace of purchases may create a shortage of bonds down the line and that extending the scheme may require the ECB to change some of the rules of engagement to avoid hitting technical limits.
These issues, along with the ECB's failure to revive the market for asset-backed securities, have raised the prospect of an expansion in the range of assets that the ECB can buy to include corporate bonds or even equities.
But its direct involvement in private corporations could meet political and internal resistance.
Markets currently see a 50% probability of a further cut in the deposit rate from -0.20%, according to Morgan Stanley estimates. Such a move was seen as effective in knocking down the euro, but would be unprecedented and could damage the ECB's credibility as Draghi has repeatedly said no more deposit rate cuts were possible.
The lack of obvious solutions and the diminishing effectiveness of QE in driving up inflation raise questions about whether the ECB has effectively exhausted its toolbox.
ECB governing council member Ewald Nowotny said last week that "new instruments" were needed. He cited economic reforms, deeper European integration and measures to stimulate demand, which was seen as a reference to more expansive fiscal policies.
With monetary policy already ultra-accommodative and the eurozone faced with structural challenges including an ageing population, some economists went as far as saying the ECB may eventually have to pare back its ambitions.
"In a scenario of prolonged undershooting of inflation, the ECB will need to be open to the idea of taking a longer time to meet the target or reformulating the target," said Anatoli Annenkov, an economist at Societe Generale.
