The eurozone must follow the examples of the UK, US and Japan by turning to the printing presses to avoid the threat of damaging deflation, according to an assessment by a leading economic think-tank.
The latest outlook report from the Organisation for Economic Co-operation and Development (OECD) shows the UK registering the fastest improvement in prospects for this year and next, thanks to a broadening economic recovery and a push from the Government's Help to Buy housing initiative.
However, the OECD blamed a slowdown in emerging markets for dragging on the world's recovery as it trimmed its global growth estimates for next year from 4 per cent to 3.6 per cent.
It also provided a sobering assessment of the eurozone, which is expected to expand by just 1 per cent next year after contracting by 0.4 per cent in 2013. Eurozone unemployment is not expected to fall from record highs until 2015 at the earliest, while inflation in the 17-nation single-currency bloc – the UK's biggest trading partner – fell to its lowest level in nearly four years in October as the economy struggled to recover after emerging from its longest-ever recession between April and June. This prompted a shock cut in interest rates to 0.25 per cent by the European Central Bank (ECB) earlier this month.
Although the eurozone is still far from the outright deflation that has plagued Japan since the early 1990s, the OECD's chief economist, Pier Carlo Padoan, said the risks "may be slowly increasing".
He added: "The ECB must be very careful and be prepared to use even non-conventional measures to beat any risk of deflation becoming permanent."
The ECB is banned from buying bonds directly from governments under treaties, but it can buy them from banks on the secondary market. The central bank has run its own bond-purchasing programmes in the past but has always withdrawn an equivalent amount of money from markets – in effect, not printing new money – to ensure its interventions have no impact on the money supply, for fear of pushing up inflation.
Any move to outright quantitative easing is likely to be resisted by the inflation-averse Germany, which also opposed the recent rate cut.
The ECB injected more than €1trn (£861bn) into the banking system via ultra-cheap three-year loans in December 2011 and February 2012, under so-called long-term refinancing operations. "LTROs have already been used and could be used again, but maybe the ECB could think about forms of asset acquisitions," Mr Padoan said.
In the UK, the OECD forecasts that interest rates will rise in 2015 after a significant pick-up in economic growth to 2.4 per cent next year; the forecast in its June report was for growth of 1.5 per cent. However, the Paris-based think-tank also flagged the risk that the Chancellor's flagship Help to Buy scheme could fuel a house price bubble.
"Despite recent progress in reforming the planning system, it is urgent to continue to relax the barriers to housing supply to prevent overheating in the property markets," the report said.
The OECD warned: "Vigorous house price increases could boost wealth and private consumption, but could also undermine affordability and stretch the balance sheet of first-time buyers."
It forecast that interest rates will rise from the historic low of 0.5 per cent to 1 per cent in the last three months of 2015 as the economy normalises.
The Bank of England has raised the prospect that interest rates – and the mortgage payments of millions of homeowners – could rise in 2015 with its prediction that unemployment may well fall to 7 per cent, the threshold for considering interest rate rises under its "forward guidance" regime.