The Paris-based economic research agency in a report also called for 'more centralised and integrated' cross-border financial supervision in the euro zone.

It urged governments to be careful with their financial sector intervention as they confront an acute economic downturn, making sure that imprudent money managers are not rewarded.

Economic growth in the countries sharing the euro is projected to have fallen sharply from 2.6 per cent in 2007 to 1.0 per cent in 2008 and should come to negative 0.6 per cent this year before edging up to 1.2 per cent in 2010.

European Union data released last week showed that the euro zone economy entered its first official recession in the third quarter, when the bloc's combined economy shrank by 0.2 per cent after contracting by the same amount in the second quarter.

The slump marks the first recession, which economists usually define as two consecutive quarters of contraction, suffered by the bloc since it was formed in 1999.

'Today's priority for all member states is to find responses to the financial crisis and ensure their swift implementation,' the Organisation for Economic Cooperation and Development argued.

But it warned that 'policy actions that would undermine longer-term objectives should be avoided.' The study noted a steady decline in eurozone inflation since July, which it said 'could well drop below 2.0 per cent during the course of 2009'.

OECD economist Nigel Pain said the organisation 'doesn't exclude deflation in the very short term if the fall in inflation is more rapid than expected'. The European Central Bank's inflation target is for a rate just under 2.0 per cent.

The OECD said that with sluggish growth and moderate wage and price pressures 'room for further easing of monetary policy would emerge', adding that if output were to decline more rapidly, 'deeper interest rate reductions could prove necessary'. By contrast if inflation pressures proved to be stronger than anticipated, monetary policy would have to tighten.

The OECD report came a day before the ECB was widely anticipated to make further reductions in its benchmark interest rate, currently at 2.50 per cent after three successive cuts since October.

Analysts have said the cut expected on Thursday would not be the last by the ECB, especially if euro zone inflation were to fall into negative territory.

The financial crisis brought on the by collapse of the US sub-prime or high risk mortgage sector has stunned markets in the eurozone and elsewhere, leading to calls for stricter financial oversignt.

The OECD said it was therefore important for the euro zone to achieve a 'coherent system of financial supervision'. It put forward two options: a single European financial supervisor or a European system of supervisors, with a central agency working together with national supervisors.

'Either option has the potential to improve the monitoring and containment of systemic risks within the rapidly growing and increasingly integrated European financial market,' the report said.

The OECD cautioned euro zone leaders who might be tempted to bail out floundering banks, maintaining that such interventions should be 'timely and temporary, mindful of taxpayers' interests'. They should also ensure that existing shareholders 'bear the consequences of the intervention and that management does not receive undue benefit'. OECD analysts acknowledged that in the present climate governments might need to resort to 'exceptional' spending measures, making use of their discretionary powers.

But it added: 'Any discretionary easing should be timely, targeted and temporary.' -- AFP