Draghi's stimulus hints put ECB in Trump's crosshairs

© Reuters. FILE PHOTO: Mario Draghi, President of the European Central Bank (ECB) holds a news conference on the outcome of the Governing Council meeting at the ECB headquarters in Frankfurt

By Francesco Canepa and Balazs Koranyi

SINTRA, Portugal (Reuters) - The European Central Bank will ease policy again if inflation fails to accelerate, ECB President Mario Draghi said on Tuesday, signaling one of the biggest policy reversals of his eight-year tenure and provoking the ire of U.S. President Donald Trump.

With four years of unprecedented stimulus to revive the euro zone economy slowly bearing fruit, the ECB had been preparing markets for policy tightening, dubbed "normalization" -- only to see a global trade war derail its plans within months.

The problem is that with rates at record lows and the ECB's balance sheet already swelled to 4.7 trillion euros ($5.3 trillion), its remaining ammunition is limited, raising doubts about the likely effectiveness of any further measures.

"In the absence of improvement, such that the sustained return of inflation to our aim is threatened, additional stimulus will be required," Draghi told the ECB's annual conference in Sintra, Portugal.

With just four months left of his term, the slowdown is also a threat to Draghi's legacy. The Italian's promise in 2012 to do "whatever it takes" to save the euro is widely credited with holding together the currency bloc during the darkest days of its sovereign debt crisis.

"(We) will use all the flexibility within our mandate to fulfill our mandate -- and we will do so again to answer any challenges to price stability in the future," Draghi said on Tuesday. "Monetary policy remains committed to its objective and does not resign itself to too-low inflation."

But the ECB is not alone in having to backtrack.

After abandoning interest rate hikes, the U.S. Federal Reserve may this week signal cuts in borrowing costs as global turmoil erodes confidence, hitting stocks and global trade.

Trump, who has persistently called on the Fed to ease monetary policy, accused Draghi of trying to weaken the euro to gain an unfair advantage in trade.

"Mario Draghi just announced more stimulus could come, which immediately dropped the Euro against the Dollar, making it unfairly easier for them to compete against the USA," Trump wrote on Twitter. "They have been getting away with this for years, along with China and others."

Trade is a main policy issue for Trump, who has raised disputes with a number of rival world economies including the European Union.

Draghi's comments, which markets saw as unexpectedly dovish, sent the euro down by a quarter of a percent against the dollar while stocks erased early losses and euro zone bond yields fell further, many into record-low territory.

Draghi has often said the ECB does not target a currency level, even if the exchange rate is an important factor for policy.

RATE CUTS, QE

Draghi said the ECB, which has consistently undershot its inflation target of just under 2% since 2013, could still cut rates, adjust its interest rate guidance and had "considerable headroom" for more asset purchases.

He also said the ECB could offer "mitigating measures" to offset the unwanted side effects of negative rates, a comment indicating that a multi-tier deposit rate was also on the table.

Adding an argument for urgency of action, he noted that risks to growth in the 19 countries that use the euro are tilted to the downside and that indicators for the coming quarters point to lingering softness.

The ECB will use the "coming weeks" to study its options, he said, suggesting that action may come sooner rather than later.

ECB policymakers next meet on July 25.

Markets have already priced in 15-20 basis points of cuts in the ECB's minus 0.40% deposit rate -- a big change compared to the start of the year, when rate hikes were firmly on the table.

LIMITS

Draghi dismissed concerns about the ECB's depleted policy arsenal, particularly the effectiveness of further bond purchases, saying self-imposed limits such as a rule that prevents the ECB buying more than one-third of a particular country's debt, could be adjusted.

He said the limits are flexible because the ECB's legal powers allow it to deploy tools that are both necessary and proportionate, adding that the European Court of Justice had already confirmed it had broad discretion.

The ECJ cleared the asset purchases in an earlier ruling but argued that limits on the ECB's bond buys must be in place, suggesting that any tweaks to those limits could see the central bank back in court.

"We are committed, and are not resigned to having a low rate of inflation forever or even for now," Draghi said.

"That aim is symmetric, which means that, if we are to deliver that value of inflation in the medium term, inflation has to be above that level at some time in the future."