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Low inflation back in focus at ECB policy meeting

Thursday, September 3, 2015 - 15:28
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The European Central Bank may have to consider fresh policy measures to prevent deflation in the single currency area, but will not move at its meeting Thursday, analysts said.

[FRANKFURT] The European Central Bank may have to consider fresh policy measures to prevent deflation in the single currency area, but will not move at its meeting Thursday, analysts said.

"After all the Greek excitement over the summer, the ECB had probably been hoping for a very ordinary and dull meeting this week," said ING DiBa economist Carsten Brzeski.

"Unfortunately... latest market turmoil and, above all, the plunge in commodity prices should revive the deflation debate within the ECB's governing council," he said.

Mr Brzeski was confident that ECB chief Mario Draghi would not announce any new policy action on Thursday.

But "on the back of lower inflation projections and increased uncertainty, Mr Draghi will - in our view - open the door for stepping up QE," or the contested bond-purchase programme known as quantitative easing, he said.

UniCredit economist Marco Valli agreed.

Mr Draghi "is likely to sound more dovish than he did in July," Mr Valli said.

"We do not expect any explicit hint that the ECB is reconsidering its policy stance at this stage, but the door for further stimulus remains wide open," Mr Valli said.

The International Monetary Fund on Wednesday insisted that global central banks must ensure that monetary conditions remain "accommodative to prevent real interest rates from rising prematurely." And addressing the ECB directly, it said the QE programme had "improved confidence and financial conditions, and raised inflation expectations initially.

"More recently however, inflation expectations have reversed, and the euro has strengthened, which could put downward pressure on prices. Hence, the programme should be extended if there is not sufficient improvement in inflation consistent with meeting medium-term price stability objectives," it said.

Fears of deflation - a dangerous spiral of falling prices - persuaded the ECB to launch in March its controversial QE programme, under which it plans to purchase 60 billion euros (S$95.4 billion) of sovereign bonds each month until September 2016, or 1.14 trillion euros in all.

Initially the scheme appeared to work, slowly pushing inflation back up in core eurozone economies such as France and Germany.

But euro-area inflation still stood at only 0.2 per cent in August, way off the two percent level which the ECB regards as conducive to healthy economic growth. And that target may not be attainable until 2018.

Falling oil prices and signs of an economic slowdown in China spooked stock markets worldwide last week. And with the euro seen as a safe haven for investors, the strengthening single currency could undermine exporters' competitiveness and also exert downward pressure on inflation.

The ECB is scheduled to publish its updated growth and inflation forecasts for the 19 countries that share the euro on Thursday and central bank watchers expect the projections to be downgraded noticeably.

"While we still think that sustained deflation remains very unlikely, consumer price inflation still looks set to remain below its target for a sustained period of time," said Ben May at Oxford Economics.

"Indeed, on balance, we now think that inflation will rise a little more slowly next year than assumed in our August baseline forecast. On its own, this may not be enough to prompt an expansion of QE. But further bad news from China or renewed euro strength might eventually be enough to trigger additional or extended support via asset purchases," he said.

Deka Bank economist Kristian Toedtmann said that at the traditional post-meeting press conference, ECB chief Mr Draghi "is likely to stress the downside risks. But the scenario he will paint will not yet be threatening enough to warrant immediate action." Instead, Mr Draghi was likely to underline the ECB's readiness to ease monetary conditions still further should the economic outlook deteriorate substantially, Mr Toedtmann said.

ECB executive board member Benoit Coeure insisted recently that "we do not wake up every morning and look at the economic indicators in order to decide whether to raise or lower interest rates or whether to stop or expand QE. We have a medium-term perspective." And he added: "We would only see ourselves forced to act if there was a fundamental change in the economic situation or the monetary stance was materially altered because of developments in the markets."

AFP