Currency Brief: Raised fears of deflation pump up pressure on ECB

on Jan 8, 2014
Updated: Oct 21, 2019
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Eurozone inflation rose in December at an annualised rate of just 0.8 per cent, down on November’s 0.9 per cent, Eurostat reported yesterday in a first estimate that will be revised in the weeks ahead.

The ECB’s mandate to keep price growth steady at about two per cent is thus under sustained attack from disinflation, a condition in which the rate of inflation is falling. If this direction continues, much of Europe could face outright deflation – an aggravated economic condition in which prices actually decline across the board.
Notwithstanding, few economists expect the ECB to take action when its Governing Council meets Thursday in Frankfurt. But the issue is certain to be an important part of the discussions amongst the central bank’s president, Mario Draghi, and his colleagues.

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Of greatest concern to economists evaluating the data released yesterday is the “core” inflation rate, which strips out potentially volatile food and energy prices and which dipped to 0.7 per cent – a record low since the introduction of the single currency. The core number for December was equivalent to the broader, overall figure for October which led the ECB to halve its benchmark interest rate to a record low of 0.25 per cent.

Clemente De Lucia, an economist at BNP Paribas, commented yesterday that the December consumer price data might have been affected by a change in the methodology by which Germany calculates its inflation, so another month or two might be needed to be certain of the trend. “Yet, the level of inflation remains dangerously low.”
What’s actually wrong with deflation though? Falling prices drag on economies, hurting corporate profits and leading consumers to delay purchases in anticipation of even better prices in the future, so exacerbating the downwards spiral. Deflation also weighs heavily on borrowers, making loan repayments more expensive in real terms – a particular danger for Europe’s already fragile financial sector.

Some analysts see Europe’s deflationary pressure as an indication of a larger problem scenario, in which austerity measures and imbalances in Eurozone countries and others in Europe have injured growth.
Jacob J. Lew, the United States Treasury Secretary, said at a news conference in Paris yesterday that Europe needed to focus on investment and stimulating demand to build momentum at a time when the US Federal Reserve was beginning to exit stimulus on persistent signs of accelerating US economic growth.

The ECB’s Draghi asserts that the central bank’s arsenal for fighting falling prices is not yet exhausted, with the possibility remaining of negative interest rates – in effect, punishing commercial banks for depositing funds at the central bank instead of putting them to work in the wider economy. Increased lending into the commercial and private sectors could produce at least a mild inflationary effect.

The minutes of the Federal Open Market Committee’s most recent meeting, that in December, are due for release at 19.00 UTC today. One insight in the array of possible stances is yesterday’s statement by Eric Rosengren, president of the Boston Federal Reserve Bank, that the Fed should reduce its bond purchases very gradually. “We do not want”, said Rosengren, “premature tightening of monetary policy to delay the return to more normal economic conditions”. He was the only member of the FOMC to vote last month against a start to tapering.
The ADP US Employment Change for December is due out at 13:15 UTC today. It should provide some guidance on the official NFP data due Friday.
Germany’s Trade Balance for November is out at 07:00 UTC and Factory Orders for November at 11:00 UTC. Eurozone November Retail Sales and Unemployment Rate are scheduled for released at 10:00 UTC.

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