Euroland in Deflation, but Trichet Couldn’t Care Less
EUROZONE INFLATION FALLS TO ZERO
By Ralph Atkins in Frankfurt, May 29, 2009
Eurozone inflation has fallen to zero, the lowest since comparable records began in 1991, and could fall even lower as a result of the region’s severe recession as well as cheaper oil prices.
The annual inflation rate in the 16-country region fell from 0.6 per cent in April to 0.0 per cent this month, according to Eurostat, the European Union’s statistical office.
Among the eurozone’s biggest countries, Germany and Spain have already reported negative national inflation rates.
The worry for the ECB will be that below-zero inflation rates will stoke fears of full-blown deflation – generalised and persistent falls in prices that wreak significant economic damage.
Jean-Claude Trichet, ECB president, warned earlier this month that eurozone inflation was likely to be negative “for some months”. He argued recent falls reflected the statistical effects of last year’s oil price rises and forecast a pick up in inflation later this year. The ECB also argues that long-run inflation expectations – which it watches closely – remain in line with its goal of an annual inflation rate “below but close” to 2 per cent.
However, the latest inflation data were weaker than expected and economists believe the recession will reduce inflationary forces further in coming months.
“The severe contraction in activity has created a huge margin of space capacity in the economy, which will exert strong downward pressure on core prices,” said Martin van Viet at ING bank. “There remains a real risk that the eurozone will see more than a whiff of deflation.”
Forward-looking confidence indicators have suggested the eurozone is contracting at a much slower pace than at the start of the year. But latest ECB credit data underscored the continuing weakness of eurozone economic activity. They showed annual growth in eurozone mortgage lending and consumer credit turned negative in April for the first time since the launch of the euro in 1999.
The ECB has cut its main interest rate by 325 basis points since last October to 1 per cent, the lowest ever, and is not expected to announce any change after its meeting next week.
But it has followed the US Federal Reserve and Bank of England in announcing an emergency asset purchase programme to help revive financial markets. The ECB will next week announce details of its plans to buy €60bn in “covered bonds, which are issued by banks and backed by public sector loans and mortgages.
One likely solution is that the package will be split according to eurozone countries’ capital shares in the ECB, which would result in Germany accounting for about 25 per cent of the €60bn programme.
GERMAN PRICE FALLS ADD TO ECB PRESSURE
By Ralph Atkins in Frankfurt, May 27, 2009
German inflation has turned negative for the first time in more than 20 years, fuelling fears of a fall in prices across the eurozone that will add to pressures facing the European Central Bank as it grapples with Europe’s severe recession.
Consumer prices in Germany fell 0.1 per cent this month from a year ago on a European harmonised basis, the country’s statistical office said on Wednesday. The unexpected drop was the first negative annual inflation rate since comparable records began in 1996 and since March 1987 on the previous basis.
Inflation has tumbled on the back of steep falls in oil and commodity prices but also on weaker economic activity. “Energy is behind the wild swings, but core inflation is easing quite a lot and that is because we have the deepest recession since the 1930s,” said Dirk Schumacher at Goldman Sachs in Frankfurt.
The worry for the ECB, which has ensuring “price stability” as its main task, is that falling headline inflation rates fuel fears of a damaging deflation phase – in which generalised price falls wreak significant economic damage.
The ECB has warned that headline eurozone inflation rates are likely to turn negative for some months and thus undershoot by a large margin its definition of price stability – an annual inflation rate “below but close” to 2 per cent.
It argues short-term inflation trends are irrelevant for monetary policy and sees inflation rising later this year. More importantly, it sees long-term expectations for inflation still in line with its goal. Core eurozone inflation, which excludes volatile energy and unprocessed food costs, has remained positive – except in Ireland.
However, Julian Callow, European economist at Barclays Capital, warned negative headline inflation would create “an important communication challenge” for the ECB. The risk was that a bout of “benign deflation” became malign, he said. The speed at which inflation had eased in Spain and Ireland, suggested that prices were proving more responsive to the crisis than might have been expected, Mr Callow argued.
Since last October, the ECB has slashed its main policy rate by 325 basis points to 1 per cent, the lowest ever. Jean-Claude Trichet, ECB president, has been careful not to rule out further cuts in interest rates or additional emergency measures. However, next week’s meeting is expected to see official interest rates left unchanged.