ECB get ready to turn on the tap as deflation looms

The European Central Bank last week indicated that it is leaning toward more quantitative easing if the euro-zone recovery shows signs of faltering.

In language that was unusually blunt, ECB President Mario Draghi said at a press conference following a regular monthly meeting that the central bank would maintain its loose monetary policies, in contrast to the Federal Reserve, and was ready to "take further decisive action if required." Although the European Central Bank kept its key lending rate at 0.25%, Draghi's remarks were widely construed as loud verbal intervention.

The euro responded by dipping below $1.36. It traded at $1.359 at midday Friday, down 1.1% since the beginning of 2014. Most currency strategists expect the common currency to lose value against the dollar in 2014.

Observers expect some sort of modest policy easing around the end of the first quarter, triggered by tightening in financial markets or fears of inflation. Any move could come sooner rather than later, as the ECB attempts to decouple euro-area rates from a prospective rally in the U.S., where the Fed announced in December that it would begin tapering its bond-buying in January.

Falling inflation is a huge worry for the ECB. If weak prices begin to tumble further, deflation could become self-fulfilling. What measures the central bank might use remain to be seen, but more long-term refinancing operations or negative interest rates might not be the weapons of choice. Instead, it could opt for some sort of asset purchases that would rekindle bank lending, such as buying securities backed by loans to small businesses. But the central bank is keen to stress that all options are open.

Investors snapped up Irish 10-year bonds last week, sparking a flurry of issues from other countries at the periphery of the euro zone. But the enthusiastic response masks worries about member governments' long-term financial health. In part, the warm welcome reflects the progress made by some troubled euro-zone nations in repairing their economies from the devastating effects of the sovereign-debt crisis. More telling, though, is the volume of investment sloshing around Europe's fixed-income markets and the elusive search for compelling yields.