(Reuters) - Monetary policy in OECD countries should remain strongly accommodative given the weak economic outlook, meaning interest rates close to zero in most cases and further support from non-conventional measures, the OECD said on Monday.
The Organization for Economic Co-operation and Development said in its twice-yearly economic outlook that, given the downside risks to growth, economies which had begun to tighten rates should reduce them.
It also urged monetary authorities in most countries to prepare contingency plans, including unconventional and untested options, in case of downside shocks.
For the euro zone, where a spiraling debt crisis has dried up credit and is crushing confidence, the ECB should press ahead with further rate cuts after reducing its main refinancing rate to 1.25 percent this month, shortly after new president Mario Draghi's mandate began.
The weak prospects for the euro area economy and fading inflation strongly argue for further prompt reductions in interest rates, the OECD said.
The European Central Bank should also ensure ample liquidity provision to lower the interbank rate to around the 0.35 percent level seen following the collapse of investment bank Lehman Brothers in September 2008.
In the United States, the OECD said the Federal Reserve should look to keep its Fed Funds rate at the current level of 0.25 percent until end-2013 -- slightly longer than the mid-2013 date the Fed has so far signaled for keeping the policy rate exceptionally low.
The OECD noted that U.S. bond yields should gradually rise in the meantime as the United States' safe-haven status dissipates.
The Bank of Japan, meanwhile, should keep its zero interest rate policy and expand its asset purchase program until inflation hits its implicit 1 percent target, the OECD said.
Similarly, the Bank of England should stand ready for further quantitative easing if inflation comes down rapidly. The OECD had factored in an additional 125 billion pounds of bond purchases into its economic estimates.
In emerging economies, meanwhile, falls in commodities prices were easing inflationary pressures but the pace of eventual monetary easing must take into account that inflation is often starting from well above target, the OECD said.
In China, it urged monetary authorities to allow a more significant appreciation of the yuan's effective exchange rate, noting this would increase policy room for maneuver by making inflation easier to control without excessive reliance on interest rates.
A useful first step in this direction would be to manage exchange rates with reference to a clearly defined basket of currencies, the OECD said.
Without such a currency policy, the need for tight domestic monetary policy could risk an excessive economic slowdown, particularly if there was a downward spiral in property prices which would in turn impact on bank capitalizations.
In Brazil, the central bank had ample room to reduce the policy rate further, while in India easing would become possible once inflation starts to decline in the second half of 2012, the OECD predicted.