By Francesco Guarascio
BRUSSELS (Reuters) - The European Central Bank should maintain a "firmly accommodative" monetary policy for an "extended period", the International Monetary Fund said on Tuesday, as it forecast inflation remaining below target.
As the ECB prepares for a decision in autumn on whether to claw back its stimulus program, the IMF said calls for an exit from easy-money policy were "premature" because consumer prices were not increasing enough.
In its annual report on the euro zone, the IMF estimated euro zone inflation will reach 1.6 percent this year before slowing to 1.5 percent in 2018, below the ECB target of below but close to 2 percent.
The forecasts were actually stronger than the ECB's latest one, released in June, which predicted the bloc's inflation rate at 1.5 percent this year and 1.3 percent in 2018.
"The costs of a long period of inflation undershooting continue to exceed those of a temporary overshoot," the IMF said.
"The calls from some quarters for an exit from monetary accommodation are therefore premature," it added. Germany has been the biggest critic of ECB's 2.3 trillion euro ($2.7 trillion) money-printing program.
To help a sustained recovery of inflation, the IMF encouraged Germany and other euro zone's countries with high growth to push for "robust" wage and price rises, even if this could bring domestic inflation beyond the 2 percent limit for a limited period.
Germany, the bloc's largest economy, should also increase public investments, a move that could stimulate growth and structural reforms in weaker euro zone's countries, such as Italy, it said.
At the same time, Italy and other high-debt countries should take advantage of the recovery to carry out reforms and build buffers against future shocks, the IMF recommended.
The IMF upgraded on Monday its output growth projections for the euro zone to 1.9 percent this year, and to 1.7 percent in 2018.
BANKS AND BAD LOANS
In spite of an improved outlook, the euro zone maintains vulnerabilities, especially in its banking sector, the IMF said.
It called for a speed up of the offloading of bad loans from banks' balance sheets, which hamper lending and slowdown economic growth.
The Fund recommended setting "ambitious reduction targets" for bad loans, also known as non-performing loans (NPLs), and urged "a firm approach to closing failing banks".
Italy, the euro zone's country with the highest amount of NPLs, has used exceptions in EU rules on bank rescues to salvage two Veneto regional banks and the country's fourth lender, Banca Monte dei Paschi di Siena (MI:BMPS).
At the same time, the IMF supported EU plans to develop a functioning secondary market for bad loans to increase their prices and avoid fire-sales of bank assets.
The fund also favored plans to set up national asset management companies (AMCs) to acquire bad loans, dismissing earlier ideas for a pan-European AMC as less effective.
The European Commission is set to make proposals on these issues after EU states adopted a common strategy on bad loans earlier in July.
To strengthen the euro zone's banking sector and its financial stability, the IMF also recommended to set up a common scheme to insure deposits at EU level and the establishment of a fiscal capacity for the bloc, which could help offset future shocks.