Fed and Bank of Japan officials flag deflation risks

By Alister Bull and Leika Kihara

EVANSVILLE, Ind./TOKYO (Reuters) - U.S. Federal Reserve and Bank of Japan officials said they were on alert for signs of deflation and grappling with how the central banks would keep it at bay as interest rates approach zero.

St Louis Federal Reserve President James Bullard said the Fed may have to resort to so-called quantitative easing that relies on massive liquidity injections into the banking system.

Bank of Japan Governor Masaaki Shirakawa said such injections had helped pull Japan out of a decade of deflation that began in late 1990s, but he would not comment on whether it be the best response to a slump sparked by the global financial crisis.

Central bankers, who only few months ago were struggling to contain an inflation flare-up stoked by soaring commodity prices, are now trying to prevent global market mayhem from degenerating into a cycle of falling prices and economic output.

Consumer demand is plummeting across the industrialised world and U.S. consumer prices fell at a record pace in October, but Bullard said deflation was still a remote risk.

"It would take some doing to get some deflation," he told a regional economics conference.

"If we do our job it won't happen and we're dedicated to that."

The task of avoiding deflation has been complicated by sharp interest cuts by major central banks to avert economic collapse after a credit squeeze triggered by U.S. mortgage defaults threatened to rupture the global financial system.