By Toby Sterling
UTRECHT, Netherlands (Reuters) - The European Central Bank faces clear limits on the use of sub-zero interest rates but inflation, its biggest concern, could actually surprise on the upside after years of forecast misses, ECB Vice President Vitor Constancio said on Wednesday.
The ECB is fighting super low inflation, which has missed its target of almost 2 percent for three straight years and the bank is buying 1.74 trillion euros worth of assets, hoping to boost growth, jobs and eventually consumer prices.
Still, even with unprecedented stimulus, the bank only expects inflation to rise to 1.6 percent in 2018, a figure Constancio said may be too pessimistic given some measures that have yet to be implemented.
"Personally, I believe that without upheavals in the world economy we can reach a slightly higher level of inflation in 2018," Constancio told a conference in Utrecht. "The full implementation of our policy package adopted last March is still going to produce effects in the forthcoming months."
The bank started its corporate bond purchases last week and a new round of ultra cheap loans will be offered later this month, keeping further stimulus in the pipeline.
The bank is also expected to keep its rates in negative territory for an "extended period", even as it grows increasingly conscious of the potential negative side effects.
"There are limits to the use of negative rates if maintained over a protracted period of time," Constancio said. "At some stage, banks may be passing on the cost of the negative rates by increasing lending rates to boost their margins which would be detrimental to our final objectives."
Nevertheless, Constancio argued that banks will benefit overall until 2017 and there were also no signs of general asset bubbles, even if critics in Germany argue that the low rates are squeezing banks and eroding household savings.
"Together with national authorities, we are prepared to intervene with supervisory and regulatory tools should this be needed," Constancio said.
"Nonetheless, the proposition that the ECB should pre-emptively resolve financial stability issues with monetary policy tools at the expense of delivering on the mandate of price stability is both wrong and very hazardous."
He added that while some pockets of overvalued real estate prices may be visible, they were isolated and there were no broad signs of bubbles.
($1 = 0.8898 euros)
(Reporting by Toby Sterling; Writing by Balazs Koranyi; Editing by Robin Pomeroy)