Economic activity in the euro area should gradually recover later in 2013 but there are more negative risks than positive ones, European Central Bank President Mario Draghi said today.
The euro zone economy contracted in the second and third quarters of last year, meeting the technical definition of recession, and the downturn is expected to have deepened in the fourth quarter.
"The economic weakness in the euro area is expected to prevail in the early part of 2013," Draghi told a news conference after the ECB left its main interest rate unchanged at 0.75%.
"Later in 2013, economic activity should gradually recover, supported by our accommodative monetary policy stance, the improvement in financial market confidence... as well as a strengthening of global demand," he said.
Draghi's outlook for the year was similar to the one he gave a month ago.
The ECB president also said that inflation will likely fall below the 2% target in the coming months and that economic growth would likely resume thanks to low borrowing rates, an improvement in financial market conditions and a pick-up in global demand.
He said that the risks to inflation are "broadly balanced" but that the risks to growth are "to the downside."
The ECB boss also said it will monitor the impact of a strengthening euro on the currency bloc's economy but said it was not a policy target and showed growing confidence in the region. Mr Draghi said the exchange rate was near to its long-term average but went further than many analysts had expected.
"The appreciation is, in a sense, a sign of return of confidence in the euro," he said. "The exchange rate is not a policy target, but it is important for growth and price stability and we certainly want to see whether the appreciation is sustained and will alter our risk assessment as far as price stability is concerned,'' he added.
Mr Draghi also said the move by banks this month to pay back early about €140 billion of cheap three-year money the ECB gave them last year was a positive sign.
"This reflects the improvement in financial market confidence," Draghi said, adding that the ECB would watch to see if the money market tightened conditions by stealth. "We will closely monitor conditions in the money market and their potential impact on the stance of monetary policy, which will remain accommodative," he said.
A Reuters poll of economists last week suggested it would not change rates until at least July 2014.
Mr Draghi was pressed about how much he knew of the derivatives scandal at Siena's Monte dei Paschi bank, and what he did about it when he headed Italy's central bank from 2006 to 2011.
Italy's third largest and oldest bank has been at the centre of a financial and political storm, facing losses of about €1 billion from a series of derivatives and structured finance trades and after a €9 billion acquisition of smaller rival Antonveneta which left it badly weakened.
Draghi said there was no implications for the ECB's future role as a European bank regulator.
"The IMF has publicly stated that their preliminary view is that the Bank of Italy took timely and appropriate action within the limits of legal framework to address problems at (Monte dei Paschi)," he said. "Oversight was close and supervisory action escalated appropriately as (Monte dei Paschi's) problems became acute."
A senior Italian central bank source told Reuters this week that Draghi was informed of doubts raised by Bank of Italy inspectors but had little control over what has been widely criticised as ineffective oversight of the stricken lender.
He has already faced criticism with former Italian economy minister Giulio Tremonti said it was "stupefying" that in his role as supervisor of Italy's banking system Draghi failed to discover or prevent loss-making derivatives trades at Monte dei Paschi.