European Central Bank President Mario Draghi, reflecting growing anxiety among Europeans about their economic plight, said on Thursday growth should be at the heart of euro zone policy but it needed to go hand in hand with fiscal austerity.
At a news conference in Spain, one of the countries worst hit by the bloc's debt crisis, Draghi painted an uncertain picture of the euro zone's economy, saying while it was likely to improve this year there were risks of decline.
Such weakness should keep a lid on inflation over time, he said, even though it would remain above 2 percent this year in the 17-nation currency area.
"The economic outlook continues to be subject to downside risks," he told a news conference in Barcelona, shortly after the bank held interest rates at a record low of 1.0 percent.
"There are indications that global recovery is proceeding … We continue to expect the euro area economy to recover gradually during the course of the year."
Police mounted a heavy presence outside the Barcelona hotel where ECB policymakers were meeting, wary of protests expected against Spanish government spending cuts that are supported by the ECB.
Draghi said there was "absolutely no contradiction" between pursuing a growth pact and pushing ahead with Europe's already-agreed pact on budget discipline.
"I certainly agree with your question when you say we have to put growth back at the centre of the agenda, without any contradiction with the need to continue, persevere in fiscal consolidation," Draghi said.
Draghi helped shift the tone of the economic policy debate in the euro zone last week when he advocated a "growth compact" without spelling out exactly what he meant.
Voters and investors are becoming increasingly disillusioned with the German-led call for austerity – summed up in the budget-constraining "fiscal compact" – as the currency bloc slides back into recession.
The ECB has pumped over 1 trillion euros into the financial system in recent months, smoothing debt issuance for euro zone members. But Spanish bond yields jumped at a debt auction held as the 23-member ECB Council met, though demand was solid.
Draghi insisted that the time was not right for the ECB to consider pulling back on some of its crisis-fighting policies, dubbing such an idea "premature".
BUNDESBANK PRESSURE
The Italian is under pressure to limit the ECB's role from Bundesbank chief Jens Weidmann, who wants countries to put their finances in order rather than looking to the central bank.
"A consistent budget clean-up and determined structural reforms are the best growth policy, because that way trust is achieved and economic performance is strengthened," Weidmann told the German weekly newspaper Die Zeit.
Draghi also faces resistance from the powerful Bundesbank to any potential rate cut or a reactivation of a bond-buying plan launched to help keep borrowing costs in the likes of Spain and Italy lower.
"The euro crisis has not escalated to such an extent recently that he would want to take on the Bundesbank on that," Berenberg Bank economist Holger Schmieding said of the bond-buying programme.
The ECB has left its bond-buying plan dormant for the last seven weeks despite a rise in benchmark Spanish yields to 6 percent. A break above that, to 7 percent, is considered an unsustainable price to pay to refinance its debt.
Weidmann told Reuters last month Spain should take the rise in its bond yields as a spur to tackle the causes of its debt woes and not look to the ECB for help.
A Reuters poll taken last week showed three-quarters of economists saw the ECB restarting its bond purchases within the next three months. However, most money market traders said in a separate poll the bank would not buy more bonds.
Spain and its problems are at the heart of a downturn of confidence in the euro zone, where fatigue with austerity is growing just as the economy shows signs of deteriorating.
The euro zone purchasing managers' index (PMI) showed the euro area's private sector slump deepened in April at a faster pace than any economist polled by Reuters predicted, dampening hopes the region will emerge from recession soon.
The prospect of the euro zone as a whole following Britain into recession has set markets wondering whether the ECB could pave the way for a rate cut later this year. It has never before lowered its main rate below 1 percent.
