OREANDA-NEWS. December 08, 2015. The European Central Bank's announcement that it will extend its asset purchase programme (APP) and further reduce its deposit rate supports our view that the eurozone will experience low, sub-target inflation but not protracted deflation, Fitch Ratings says.

We believe that the ECB's willingness to loosen monetary conditions to keep long-term inflation expectations anchored is one reason the eurozone can avoid prolonged deflation. The ECB cut its deposit rate to minus 0.3% and said that EUR60bn of monthly purchases under the APP would run until March 2017, and for longer if necessary to bring inflation back towards the target.

The impact of these measures will depend in part on market reaction. Thursday's announcement fell short of market expectations for further large scale easing, pushing the euro and eurozone government bond yields higher.

However, we think Thursday's announcement is a meaningful response to the disinflationary pressures of 2H15 from low energy prices and emerging market and global growth concerns, in the context of improving credit flows and some recent improvements in high-frequency activity data. Extending the APP by six months (the ECB originally said that the programme would run until at least September 2016, but it has always been potentially open-ended) will add EUR360bn to the ECB's balance sheet. An explicit commitment to reinvest principal payments may also extend the life of the APP, and a wider range of assets are now eligible.

The bond and FX markets had expected further easing since the ECB signalled in October that it would make a policy adjustment at its next monetary policy meeting, and have become accustomed to the central bank "over-delivering" against expectations. Nevertheless, the euro is around 4% weaker than it was before the October meeting.

Deflation should also be avoided as eurozone GDP grows (albeit slowly), better capitalised banks address high NPLs, and wages and prices remain sticky at low levels. ECB easing may reinforce this - for example a weaker effective exchange rate and easing financing conditions should support growth by boosting exports and domestic consumption.

Eurozone inflation has been persistently low, partly due to structural weaknesses in the bloc's economy, with low demand and high unemployment and debt. Eurostat said on Wednesday that annual inflation in November is expected to be 0.1%, with core inflation expected to be 0.9%. Base effects should push headline inflation higher, but underlying inflation pressure will remain subdued until 2017, when we forecast average inflation of 1.5%.

Deflation or a long period of very low inflation would present risks to eurozone sovereign ratings as weaker nominal GDP growth pushes up government debt/GDP ratios. Extending sovereign bond buying will keep financing conditions benign for eurozone sovereigns and lower the effective interest cost on public debt, most markedly in the periphery, which should partly offset some fiscal loosening next year.

Our detailed eurozone forecasts and a discussion of the prospects for growth in 2016 around the world will be available in our next quarterly "Global Economic Outlook", to be published on Monday. The December GEO's alternative scenario examines the potential impact of a shock to eurozone inflation expectations.