German tourists have left the European Central Bank with a policy conundrum ahead of this week’s rate-setting vote.
A methodological quirk in the calculation of holiday costs in the currency bloc’s largest economy helped push core inflation in the eurozone to an all-time low in December, stoking fresh fears of a Japanese-style bout of deflation.
Since headline inflation slowed sharply to 0.7 per cent in October, attention has been fixed on the threat of falling prices in a region already suffering the ill-effects of weak demand. As policy makers prepare to travel to Frankfurt ahead of Thursday’s vote, the question is whether they will act to counter this latest risk to the currency bloc’s fragile recovery.
A flash estimate from Eurostat, the commission’s statistics bureau, on Tuesday showed overall inflation slowed to 0.8 per cent in December, from 0.9 per cent the previous month. Core inflation, which excludes more volatile items such as food and energy costs, slowed to 0.7 per cent, the lowest since the series began.
Ken Wattret, economist at BNP Paribas, said: “It’s very worrying . . . The numbers enforce an existing theme: on both a headline and core basis, inflation in the euro area is uncomfortably low. And the trend is clearly downwards.”
Although the latest fall has sparked calls for the central bank to do more immediately, the chances of action at Thursday’s meeting are slim.
Policy makers have already cut the central bank’s benchmark main refinancing rate to a record low of 0.25 per cent in November and Mario Draghi, ECB president, has recently signalled the central bank – for now – has done enough. The ECB’s latest forecasts show inflation hitting 1.1 per cent this year, before rising to 1.3 per cent in 2015 and Mr Draghi has emphasised that expectations of price stability remain “well anchored” or stable.
The ECB is expected to cite the quirks in Germany’s inflation measurement as cause to stand pat.
François Cabau, economist at Barclays, said: “I’m dubious [the fall] would come as a surprise for the ECB. It’s going to trigger some concern, but the Bundesbank had already flagged this.”
Jens Weidmann, president of the Bundesbank, said in an interview with the Financial Times in December that inflation was likely to fall towards the end of the year.
Mr Cabau added: “The ECB ought to comment on it certainly . . . but they’re most likely to restate what they’ve said over the past few months, which is that inflation is going to run low for a long period of time and certainly 0.7 per cent is in line with that. I think this is a low point, I don’t see core inflation falling lower at this stage, although I continue to see risks biased to the downside.”
Most on the governing council are unlikely to call for further measures just yet. But they could be forced to act if inflation remains weak in the months ahead.
Nick Matthews, economist at Nomura, said: “While we do not believe [the fall in core inflation] is sufficient to trigger an immediate response, it further increases the importance of inflation data for the first few months of 2014, especially in view of recent comments from ECB president Draghi in an interview with Der Spiegel magazine in late December that placed emphasis on avoiding inflation ‘permanently’ below 1 per cent and the de-anchoring of inflation expectations.”
Some economists believe the fall in the core rate indicates inflation will weaken. “The path of inflation tends to be quite bumpy but we think it’s very likely that by the spring inflation will end up around 0.5 per cent,” said Mr Wattret.
Ben May, economist at Capital Economics, said: “The latest prices data support the view that CPI inflation is likely to remain significantly below the ECB’s price stability ceiling for rather longer than the central bank expects.”
If price pressures continue to dissipate, the most likely options would be another cut to the benchmark main refinancing rate or negative deposit rates, which amount to a levy on banks for funds parked in the central bank’s coffers.
An outside choice remains the outright purchase of government or corporate bonds, often referred to as quantitative easing. However, such a measure would prove contentious with the Bundesbank and members of the ECB’s executive board, such as Yves Mersch and Benoît Cœuré, who both highlighted the difficulties associated with conducting large-scale asset purchases in a monetary union towards the end of last year.