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Categorized | Economy

Eurozone deflation stirs talk of QE boost

Posted on September 30, 2015


The eurozone has spent much of the past year trying to shake off the risk of falling into Japanese-style deflation.

Last January, the European Central Bank announced a programme of quantitative easing, buying up to €60bn in assets per month, including government bonds, as it sought to return inflation to its target of close to 2 per cent.

    So when Eurostat, the European statistics agency, showed that inflation had slipped back into negative territory in September — with prices 0.1 per cent lower than a year earlier — it looked like the past nine months had been wasted.

    With inflation driven down primarily by lower energy costs, however, economists remain confident that the eurozone can still avoid a cycle of persistent falling prices. But the ECB may still be forced to expand QE, especially if the recent slowdown in emerging markets continues — hitting eurozone exports hard.

    “Just in the way that a small positive print is not enough to pop the champagne corks, a small negative reading does not on its own presage a broader deflationary spiral,” said Timo del Carpio, European economist at RBC Capital Markets. “The far bigger concern, in our view, still relates to weak underlying price pressures. The ECB will be increasingly wary about the downside risks to its mandate.”

    The fall in inflation — which was from 0.1 per cent in August — marks the first time in six months that the 19-nation currency bloc has experienced deflation. The driver was energy prices, which were 8.9 per cent lower than a year earlier, due in part to a slump in the oil market.

    However, core inflation, which strips out the most volatile items such as energy, stood at 0.9 per cent, the same as in August. Food, alcohol and tobacco prices were up 1.4 per cent in September, while the price of services rose 1.3 per cent, marginally higher than in August.

    Economists were generally encouraged by the resilience of core inflation, as well as by the improvement in services inflation.


    Increase in food, alcohol and tobacco prices in September

    “The acceleration in services inflation is good news because it comes amid [a] slowly normalising labour market and wage developments — labour cost is the main determinant of services inflation,” said Marco Valli, chief eurozone economist at UniCredit, a bank.

    But analysts point out that such positive news has to be balanced against an increasingly uncertain outlook.

    The fall in oil prices is expected to continue to boost domestic demand, as consumers feel that their pay cheques can go further. But the recovery is still too weak to generate the kind of sustained job creation which is needed for a broad-based acceleration in consumption.

    On Wednesday, Eurostat also said that unemployment in the currency bloc remained high at 11 per cent in August, the same level it stood at in July.

    “There is a recovery, and jobs are being created, said Guntram Wolff, director at Bruegel, a think-tank. “But it is not a satisfying recovery, and the pace of employment growth is too slow.”

    Externally, companies fear that the slowdown in emerging markets, China in particular, is threatening to reduce the pace of export growth.


    Unemployment in the currency bloc in August

    The other concern relates to the resilience of the euro, which strengthened against the dollar after the US Federal Reserve delayed its first increase in interest rates since the crisis.

    Were the Fed to press ahead with “lift-off” in October or December, this would help the ECB by weakening the single currency, which would in turn push up price pressures.

    But the central bank may feel that even this is not enough: future inflation expectations have been slipping again, and the central bank may want to raise them again before they go too low.

    For this reason, some economists believe that the ECB could step up its asset purchases. Standard & Poor’s said on Wednesday that the central bank could extend quantitative easing beyond the planned cut-off in September 2016 until mid-2018, swelling the programme to as much as €2.4tn.

    However, the ECB is likely to wait until December at least before taking any further step.

    Mario Draghi, ECB president, made it clear last week that the central bank was prepared to take further action if there was a risk of the slowdown becoming entrenched.

    “The [ECB’s] Governing Council will look to cement expectations over the continuation of its asset purchase programmes beyond their nominal end date of September 2016,” said Mr del Carpio. “However, it may not be until the December meeting — when new staff forecasts are released — that the Governing Council is prepared to make such a judgment.”