ECB faces pressure to cut interest rates
Pressure grew on the European Central Bank on Thursday to cut interest rates after inflation slowed sharply in the euro area. Meanwhile Germany hit back at a jibe from the US Treasury that laid the blame for deflationary trends at Berlin’s door. The euro area’s annual inflation rate unexpectedly slowed to 0.7 per cent in October, well below the ECB’s target of close to, but below, 2 per cent. The slowdown came as Germany, the biggest eurozone economy, reacted angrily to accusations by the US Treasury that its large and persistent current account surpluses created a deflationary bias in the global economy. The Treasury urged Berlin to do more to boost domestic demand. "The German current account surplus is no cause for concern, neither for Germany, nor for the eurozone or the global economy. There are no imbalances in Germany that need correction," the country’s finance ministry said. The Treasury’s semi-annual currency report, released on Wednesday, elevated the Germany criticism to a "key finding" at the top of the report – alongside China’s undervaluation of the renminbi and Japan’s monetary stimulus. It comes at a low ebb in German-US relations after allegations that the US tapped Chancellor Angela Merkel’s mobile phone. Slowing eurozone inflation highlights how sluggish the region’s recovery is and raises the risk of Japan-style deflation, when prices persistently fall. It also effectively raises the debt-reduction bar for the currency union’s crisis-hit members, since less of their national debt is inflated away over time. The so-called "flash" or initial inflation estimate by Eurostat, the EU’s statistical office, represented a further slowdown since September, when inflation was 1.1 per cent, which is roughly what economists had predicted for October. A sharp outright fall in energy costs, by 1.7 per cent, drove the slowdown in the harmonised indices of consumer prices, which the ECB targets but the "core inflation" rate, which strips out energy, food, alcohol and tobacco, also dropped, from 1 per cent to 0.8 per cent . The ECB’s governing council meets next week to discuss interest rates. It has been divided for months over whether a further cut below 0.5 per cent on its main refinancing rate would be justified. Slowing inflation and the appreciation of the euro, which may explain the energy price falls, are strong arguments for those in favour of a cut. The bloc’s fragile recovery and an expectation that inflation will pick up next year are the main reasons cited by those favouring no change on monetary policy. German policy makers, in particular, are likely to resist calls for a rate cut, given their view that monetary policy is already too loose in a country with low unemployment and rapid price rises in some parts of its property market. Despite the increased pressure to loosen policy, the central bank may yet wait until its December meeting, when new staff forecasts will give it an updated medium-term inflation forecast – the timescale over which it is meant to keep prices stable. "We see December as the most probable timing for a 25 basis point cut in the refi [refinancing] rate, in tandem for another round of low staff projections for inflation," Ken Wattret, economist at BNP Paribas, said in a note. Unemployment data for the bloc, also released by Eurostat on Thursday, remained stable at 12.2 per cent in September compared with the August rate. This illustrates how the bloc’s recovery has yet to help reduce unemployment, which is highest in Spain and Greece, where more than one in four is out of work. Although Portugal reduced its unemployment rate from 16.5 per cent to 16.3 per cent, the lack of major progress on jobs fuels the disinflationary trend as there is no upward pressure on wages. Economists at Commerzbank pointed out that wage freezes and cuts were helping companies in stressed countries improve their competitiveness. "The low rate of inflation is a positive sign as it is largely due to weak price pressure in the crisis countries," Commerzbank’s Christoph Weil said in a note. "Declining prices in Greece and Spain confirm that companies are using the drop in unit labour costs to improve their price competitiveness." However, inflation is also undershooting in Germany, where it slowed from 1.4 per cent in September to 1.2 per cent in October, according to the federal statistics office. The German slowdown was attributed to lower petroleum prices in October compared with a year ago. If the ECB does decide to cut its refinancing rate it will have to choose between lowering its 0 per cent deposit rate into negative territory for the first time, or narrowing the corridor between the two rates. A narrower corridor between the rate at which it lends money to commercial banks and pays them for their deposits could disrupt how money markets function. A negative deposit rate, where the ECB would in effect charge banks to deposit funds with it, would be a first for any major central bank and could also lead to unexpected consequences.