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German index slump increases talk of ECB action

FRANKFURT, Germany -- A fall in business confidence in Germany has added to the troubling signs about the European economy as speculation grows that the European Central Bank (ECB) may take further action to keep the recovery from stalling completely.

Germany's Ifo institute said Monday its closely watched business confidence index dropped to 106.3 points in August from 108 points in July. Market analysts had expected a dip to 107.0.

The downbeat signal from the largest of the 18 economies that use the euro follows drops in other surveys of business activity and disappointing zero growth for the currency union in the second quarter after four quarters of weak growth.

The recent data, coupled with turmoil in Ukraine and the Middle East, has been enough to shake confidence in the European Central Bank's outlook that modest growth will continue and led Monday to increased expectation the bank may take more drastic action.

The ECB launched a raft of measures in June, including a cut in its benchmark interest rate to a record low of 0.15 percent and an offer of cheap loans to banks that are willing to lend to businesses. Officials have said they want to wait to see how those steps work.

But signs are growing that the ECB and its president, Mario Draghi, may not have that luxury.

“The continued fall of the Ifo is really problematic for the rest of the euro area, which is barely growing,” Commerzbank's chief economist, Joerg Kraemer, wrote in a research note. “The ECB's optimistic economic outlook is crumbling.”

Draghi's comments late Friday at a U.S. Federal Reserve conference in Jackson Hole, Wyoming, are being taken as a sign that the bank may be getting ready to act against a slackening economy and inflation that is far too low at 0.4 percent.

Draghi has said the bank could start asset purchases, or so-called quantitative easing, if the inflation shows signs of falling further. In Jackson Hole, he departed from the text of his speech to add a warning that money market interest rates show inflation expectations have “exhibited significant declines at all horizons.” And he added that the bank would “acknowledge these developments” and use “all the available instruments” to keep prices stable.

Economist Kraemer said that the comments mean that “the probability of broad-based bond purchases (QE) is rising.”

In quantitative easing, a central bank creates new money and uses it to purchase financial assets such as bonds. That pumps newly created money into the financial system. It can in theory increase the amount banks can lend, drive down interest rates, and increase inflation. The U.S. Federal Reserve, Bank of Japan and Bank of England have all used quantitative easing. But there are legal, political and practical hurdles to doing it in a multi-country currency union and so far the ECB has held off.

Economist Frederik Ducrozet at Credit Agricole said the bank might choose to strengthen existing measures before turning to large-scale asset purchases. He said it could make the terms of its targeted loans to banks that loan to businesses even more attractive. The ECB could also speed up a program it is developing to buy bonds that are put together from loans to small businesses, in a targeted effort it says could increase funding for that smaller businesses that create most of the jobs in the economy.

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