13 May 2014

ECB ready to act as deflation looms

The creeping threat of deflation in the eurozone has finally spurred the European Central Bank into action.
​​​​​​​​The creeping threat of deflation in the eurozone has finally spurred the European Central Bank (ECB) into action.

At least that was the indication from last Thursday’s (May 8th) press conference held by the bank’s chief, Mario Draghi, who dropped his strongest hint yet that further easing is on its way.

He suggested the bank was “comfortable” with acting to stimulate inflation in June, after the bank releases its staff reports on the economic and inflation outlook.

This was important, as it seemed to show Draghi had abandoned his aim of never pre-committing to monetary policy actions. The change in mood is significant and is clearly the result of ongoing weak price inflation in the eurozone.

As Draghi explained last week, and indeed as he has done for months, the longer the period of low inflation the greater the risks for the eurozone economy.

Prices have risen by less than one per cent for months and though policymakers have consistently batted away suggestions the eurozone is entering a Japan-style era of deflation, many are coming around to the idea that this is now a real danger.

“There is consensus about being dissatisfied with the projected path of inflation, and so there is a consensus in not being resigned to this,” said Draghi.

Nick Beecroft, Chairman of Saxo Capital Markets, believes inflation is fast becoming an obsession of the ECB.

“The [Governing] Council is severely concerned about what they now see as a  prolonged period of low inflation with only a gradual pick-up in inflation in 2015,” he says.

“And it’s obvious that also it is concerned, if not obsessed, by the strength of the foreign exchange rate and the contribution that’s making to low inflation.”

Draghi has said that while the euro exchange rate is not an explicit policy target, it is “very important for price stability and for growth”.

He added that the strengthening of the exchange rate in the context of low inflation is “cause for serious concern”.

What the ECB does in June is up for debate - Draghi said the ECB Governing Council is “unanimous in its commitment to using unconventional instruments within its mandate in order to cope effectively with risks of a too prolonged period of low inflation”.

There are a number of “unconventional” tools at its disposal, though US-style quantitative easing appears unlikely due to the heterogeneous makeup of the bloc.

The most likely option and one that has been discussed previously, is to turn the deposit rate negative.

Beecroft thinks the June policy meeting will see the ECB cut its benchmark rate by 25 basis points to zero, but the bank could go a lot further than that.

He adds: “I don’t see why that has to be the end. I wouldn't even be surprised to see minus one per cent deposit rate by the time we’re through with this.”​


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Losses can exceed deposits on margin products. Please ensure you understand the risks.