Why ECB policy makers will be feeling glum after today’s inflation report

Oh, this is not a happy start to 2014 for the eurozone.

Data from the European Union’s statistics office shows that inflation in the eurozone slipped to 0.8% in December 2013 from 0.9% in November.

That is still far away from the ECB’s inflation target of 2% deemed moderate enough to stoke economic activity—and closer to the near-four-year low of 0.7% seen in October. October’s shock decline in the inflation rate was enough to prompt the ECB to unexpectedly slash the already low benchmark ‘refi’ rate of 0.5% to 0.25% in an attempt to revive consumer and business spending.

According to some analysts, December’s headline inflation figure is not the only thing that’s worrying. Core inflation – inflation excluding volatile items such as energy, food, alcohol and tobacco – slumped to an all-time low of 0.7%.

“In our view, it is the soft ‘core’ inflation print that is the main item of news in this report,” James Ashley, senior economist at RBC Capital Markets told Associated Press. “It constitutes the weakest reading on record (back to 1990) and reflects a marked slowdown in services price inflation.”

December’s  inflation data is unlikely to convince anyone that the ECB is winning the battle against falling inflation. If anything, it shows the ECB cannot be complacent about the looming threat of deflation – falling prices – which is a more dangerous economic phenomenon.

Falling prices tend to prompt consumers into  delaying purchases and businesses to delay investments (in the hope that prices/costs will fall further in the future). If deflation takes root in the eurozone, it will slow down an already fragile economic recovery.

Gross domestic product in the 17-country eurozone grew a mere 0.1% in the June to September quarter, or 0.4% at an annualised rate.

Will the latest inflation data prompt the ECB to announce new monetary easing measures on Thursday, when it holds its first policy review meeting for 2014?

That’s unlikely, according to most experts, but with each passing day, it will become increasingly risky for the central bank to continue doing nothing (without any help from fiscal stimulus measures) for too long.

There has already been some buzz about some possible easing measures: a negative deposit rate on bank reserves with the central bank, long-term loans for banks in the region and even a highly controversial (but unlikely) US Federal Reserve-style bond-buying programme.

To be sure, the eurozone needs help getting out of the economic quicksand of low to no growth. On Monday, other data showed that bank lending fell at a record pace in the eurozone in November, another stark indicator that economic activity is sagging.

With pressure piling on the ECB, it won’t be long before it acts.

[Image Credit]


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