Is More ECB Action Likely if Inflation Worsens?

During the press conference that followed the European Central Bank (ECB) meeting held in Frankfurt on February 6, 2014, ECB President Mario Draghi commented on the current low level of inflation in the Eurozone. These are some of the highlights from his discussion:

  • The worsening inflation outlook is reason for ECB action. If needed, they will take further decisive action and are ready to consider all available instruments.
  • This period of prolonged low inflation bears  no similarities to the Japanese situation (where CPI was negative for almost two decades after a financial bubble burst, reducing the availability of credit in the Japanese economy for many years).
  • There has been no broad-based price decline in the euro area. Although January inflation was lower than expected,  inflation should continue near current levels in coming months.
  • There is no deflation and low inflation is driven by energy and food prices, which have both been on a downward path since 2013.
  • Only the two counties hardest hit by the financial turmoil of recent years, Greece and Cyprus, had negative inflation readings.  Spain, Italy, Ireland and Portugal, which are currently enduring the fiscal austerity measures implemented to deal with the euro crises of recent years, reported low but positive readings based on data from November.

From Pioneer’s Perspective 

The measures the ECB have taken up until now have contributed to reassuring financial markets, and peripheral spreads in the euro area have been declining significantly. Looking forward, the ECB does not anticipate a period of outright deflation for the Eurozone as a whole, but expects it will take time for headline inflation in Greece and Cyprus to return to positive territory and increase significantly in the other peripherals as their economic situation improves. This forecast based on the following criteria:

  • Severe fiscal austerity measures currently in place seem sufficient to improve public finances in most states, so another widespread round of fiscal tightening seems unlikely.
  • Energy prices are not likely to fall significantly from current levels. The increased energy supply coming from shale oil and gas is costly to extract and would become uneconomical should energy prices decline further.
  • There are signs of economic improvement in most Eurozone economies, which may reduce disinflationary pressures.
  • Economic expansion in most developed markets should also sustain energy demand and thus support prices.
  • The political climate in the euro area is changing, with austerity likely to be rejected by a significant number of voters in the upcoming European elections in May; politicians have taken notice and some stimulative measures could be implemented in coming months.
  • The ECB seems determined to maintain an easy monetary policy going forward, and seems set to enact more measures at the March meeting.

In Summary

While we continue to expect a limited risk of outright deflation for the Eurozone going forward, its persistence at a very low level for a protracted period does pose a risk, as President Draghi has repeatedly stated. In addition, the need for peripheral economies to adjust for competitive reasons implies that their inflation rates will remain below the Eurozone average for some time. In March, the ECB will examine new three-year projections on GDP and inflation. Some ECB action is quite possible at the March meeting, either on interest rates (repo rate cut to 0.10% from 0.25% and a negative deposit rate, now zero) or on some type of further liquidity provisions, or both. The ECB under Mr. Draghi has been very inventive, so the announcement of innovative measures at the March meeting cannot be ruled out.

For a more in-depth look at the economy and the markets, download a copy of the latest Pioneer Investments Macroeconomic Report.

About Giordano Lombardo

Giordano Lombardo is CEO and Group CIO of Pioneer Investments. Prior to his appointment as CEO in February 2015, he held the position of Deputy CEO since 2012. He has been Group CIO, responsible for global investment activities, since 2001 and has been with Pioneer's parent company, UniCredit Group, for over 20 years.
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