Negative Eurozone Inflation Doesn’t Make ECB’s Job Easy
Quantitative Easing Looks a Step Closer
But the numbers still don’t make the decision straightforward for the ECB, given the complications that eurozone sovereign quantitative easing brings with it.
The eurozone still isn’t experiencing deflation, or a downward spiral in prices fueled by expectations that goods and services will be cheaper in future. December’s decline in headline inflation to minus 0.2% from 0.3% in November was driven by lower energy prices, which fell 6.3% on the year, and a drop in food prices, down 1%. That should be a boon to cash-strapped consumers.
So-called core inflation, which strips out energy, food, alcohol and tobacco, actually rose in December to 0.8% from 0.7%. That matches the 12-month average: core inflation has been low, but remarkably stable. Citigroup expects core inflation to average 0.7% this year.
Of course, the headline rate is what matters for the ECB, which aims to keep inflation below, but close to, 2%. Expectations are even more crucial. Market measures have fallen sharply, with the five-year/five-year inflation swap, a closely watched indicator of medium-term inflation expectations, now at 1.57%, according to Deutsche Bank .
The concern will be that with demand in the eurozone remaining weak, lower energy costs will prompt businesses to cut prices, leading to more entrenched downward pressure on inflation and increasing the chance of deflation. Consumers, who tend to extrapolate from the headline rate, might start to think about deferring spending. But since oil and food prices are driving inflation, it isn’t clear why that would be the case.
Nor is it clear that ECB sovereign-bond purchases would themselves address deflationary pressure from food and energy prices—except through delivering a weaker euro, where the ECB’s current efforts may already be having an effect. Barclays notes that prices for imported goods are starting to rebound, potentially providing countervailing upward pressure on inflation.
The more worrying number released Wednesday was actually the eurozone unemployment rate, which has stopped falling and remains stuck at 11.5%. That too masks underlying developments: while unemployment has fallen in Spain and Germany over the past year, it has risen in France and particularly Italy.
That is a big problem for the eurozone. But it is also a problem to be addressed by governments just as much as by the ECB.