Eurozone prices falling for first time since 2009
Development likely to reinforce expectations that ECB will soon provide an aggressive monetary stimulus
It’s official. Following months of speculation, the eurozone is seeing a fall in consumer prices, a development that’s likely to reinforce expectations that the European Central Bank will soon provide an aggressive monetary stimulus.
Lower energy costs helped turn inflation negative in the 18-country eurozone in December for the first time since the height of the global financial crisis five years ago, according to the European Union’s statistics agency, Eurostat.
Consumer prices as a whole, the agency said Wednesday, were 0.2 percent lower during the month than the year before. That’s a big drop from the 0.3 percent inflation rate recorded in November. The decline was bigger than anticipated, with the consensus in markets for a 0.1 percent fall.
The dramatic drop in the price of oil in recent months is the main reason for the fall in prices in the eurozone, which now numbers 19 states following Lithuania’s entry at the start of the year. Cheaper energy costs are being passed on by businesses to consumers, most notably at the pump. On Wednesday, the Brent crude oil contract fell below $50 for the first time since May 2009.
The huge impact of lower oil prices is evident in the fact that the core inflation rate, which excludes volatile items such as food, tobacco and energy, actually rose to 0.8 percent from 0.7 percent.
Though lower oil prices can help an economy as consumers feel they have more money in their pockets to go out and spend, the eurozone has seen a worrying slide in its inflation rate for over a year - a trend that indicates the economy is fundamentally weak.
A fall in prices is a concern for policymakers if it is sustained over a period of time, a situation often referred to as a deflationary spiral. That can choke the life out of an economy if consumers put off purchases in the hope of future bargains, and companies struggle to remain profitable. Deflation can prove difficult to reverse, as evidenced by Japan’s economic stagnation over the past two decades.
The ECB is increasingly concerned about such a scenario because the eurozone has failed to generate much growth since the recession ended in mid-2013. Separate figures Wednesday showed unemployment across the eurozone standing at a high 11.5 percent in November.
As a result, many in the markets think the ECB will back a government bond-buying program on the lines of those that have been pursued by other central banks over the past few years, such as the U.S. Federal Reserve and the Bank of England.
That expectation has weighed heavily on the euro, which hit a new 9-year low of $1.1848 on Wednesday. Because the stimulus would create new money, traders are selling the currency on the prospect of more euros in circulation.
ECB President Mario Draghi has hinted lately that the bank could announce a new measure soon to avoid the risks of deflation. The ECB’s policymaking governing council meets on Jan. 22 and many investors think that a bond-buying program, which is often referred to as quantitative easing, or QE, will be announced then. The ECB, after all, doesn’t have much left in its arsenal anyway, having already cut interest rates to record lows and backed the purchase of some private-sector bonds.
“The emergence of negative inflation does forcefully raise the specter of a possible prolonged period of deflation,” said James Ashley, chief European economist at RBC Capital Markets. “For those policymakers who, hitherto, might have been undecided over whether or not to take further action immediately, this may be just the clarion call that was required to appreciate the gravity of the situation.”
Proponents of QE say the policy can help shore up an economic recovery and support prices by reducing the borrowing costs for businesses, households and governments. The associated fall in the currency could also help boost growth by making exports cheaper and push prices up by making imports more expensive.
But officials in Germany, Europe’s largest economy, have said such a program of government bond purchases would amount to throwing money at profligate states. Germans are concerned that the country’s taxpayers will end up being burdened with the debts of countries like Greece, Italy and Portugal.
Success is not guaranteed, as evidenced by Japan’s return to recession even though the country’s central bank is enacting its own bond purchase program.