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Talk of ECB action grows as European economy fades - Worries about the economy are rippling through Europe

Published:Tuesday | August 26, 2014 | 8:00 AM

Downbeat data have pushed the European Central Bank closer to more drastic action to keep the hesitant recovery from stalling completely.

Meanwhile, open feuding in the French government about how to break out of economic stagnation saw President Francois Hollande dissolve the cabinet and order Prime Minister Manuel Valls to form a new team.

Concerns had grown so strong that by Monday investors were willing to bet that the ECB will intervene with new stimulus measures, based on comments late Friday by bank president Mario Draghi. Stocks in Europe rallied.

Draghi warned that low inflation - a sign of economic weakness - could be getting worse. Draghi also underlined the sense of urgency by telling European governments to make a more coordinated effort to boost growth through tax cuts and a new joint investment programme.

Predictions that more ECB help will be needed were reinforced Monday by a drop in Germany's closely watched Ifo business confidence index. It fell to 106.3 points in August, from 108 in July, and below market analysts' expectations for a dip to 107.

confidence shaken

The recent data, coupled with turmoil in Ukraine and the Middle East, has shaken confidence in the ECB's outlook that modest growth will continue. The ECB launched a raft of measures in June, including a cut in its benchmark interest rate to a record low of 0.15 per cent and an offer of cheap loans to banks that are willing to lend to businesses.

Officials have said they want to wait to see how those steps work. But signs are growing that the ECB and its president, Mario Draghi, may not have that luxury.

"The continued fall of the Ifo is really problematic for the rest of the euro area, which is barely growing," Commerzbank's chief economist, Joerg Kraemer, wrote in a research note. "The ECB's optimistic economic outlook is crumbling."

Draghi has said that if weak inflation - now only 0.4 per cent - shows signs of worsening, the bank could launch large-scale purchases of financial assets, known as quantitative easing, or QE. He said Friday at a US Federal Reserve conference in Jackson Hole, Wyoming, that money market interest rates now show inflation expectations have "exhibited significant declines at all horizons".

He added that the bank would "acknowledge these developments" and use "all the available instruments" to keep prices stable.

Economist Kraemer said the comments mean that "the probability of broad-based bond purchases (QE) is rising." The ECB's governing council next meets September 4.

Draghi also urged European governments to move past their recent focus on austerity and do more to boost growth with tax cuts - offset by spending cuts to remain within the strict European Union limits on government deficits.

- AP