Deflation ghoul hovers over eurozone

 
Mario Draghi

This is how the president of the European Central Bank (ECB) explained the eurozone central bank's decision to cut its policy interest rate to a smidge above nought (0.25%):

"Inflation decreased in October 2013 to 0.7%, from 1.1% in September. This decline was stronger than expected and reflected, in particular, lower food price inflation, a larger fall in energy prices and some weakening in services price inflation.

"On the basis of current futures prices for energy, annual inflation rates are expected to remain at low levels in the coming months. Underlying price pressures in the euro area are expected to remain subdued over the medium term."

Now there are a number of things to say about this.

The first (which you may already have said to yourself) is that Europe's most powerful central banker - who is supposed to know a thing or two - says energy prices are on a pronounced downward trend.

Which is not quite the message we've been getting from Centrica's British Gas, Scottish & Southern, Scottish Power and Npower.

Of course we all understand that their price rises "look backwards at the wholesale market" (as one energy boss put it to me - I am not exactly sure what that means) and include a big increment for the cost of being forced by the government to insulate homes.

But. Point the second:

The eurozone rate cut weakens the euro vis-a-vis the pound, which in turn should see lower inflation exported to the UK.

So it probably delays the moment when the Bank of England feels obliged to raise UK interest rates (to the annoyance of the gathering flock of hawks calling for rates to rise now).

Point the third:

It is not the inflation rate of 0.7% itself which the ECB sees as a worrying and dangerous thing (though that is well below the official target of just under 2%), but the pronounced downward trend in the rate - from 1.6% just four months ago.

The point is that the eurozone has only recently emerged from long and pernicious recession, and its growth remains nugatory.

If businesses and consumers began to believe that deflation was a serious prospect, they would defer purchases and investments to take advantage of falling prices - and the members of the currency union would be right back in the soup, with their economies shrinking sharply.

Worse still, there would be an even greater incentive for businesses, households and banks to reduce their debts - to save as if there's no tomorrow - because of the threat of deflation increasing the real burden of those debts.

And that would be a double whammy to spending or investing today, and thus to the recovery.

Point the fourth:

If the rate cut doesn't succeed in stimulating the economy and reviving inflation, the ECB has a bit of a problem - because there is only one interest rate cut, to zero exactly, left as ammunition in its locker.

Draghi insists he is not fretting about this, that he has different sorts of pro-inflation weapons almost to hand.

These would include charging banks an interest rate for taking their deposits, to encourage them to push money into the economy rather than parking it at the central bank.

Or the ECB could provide yet more cheap loans to banks - though it has done a good deal of this already, and hasn't stemmed the deflationary trend.

What the ECB can't do is create money in the explicit and simple way that the Bank of England and US Federal Reserve can do, through quantitative easing, because it is constitutionally prohibited from buying the sovereign debts of member states.

So if you are musing that Mr Draghi has a hand strapped behind his back in his battle against the putative demon deflation, he might not disagree.

 
Robert Peston, economics editor Article written by Robert Peston Robert Peston Economics editor

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  • rate this
    +49

    Comment number 6.

    So if I understand this.
    Without QE in Europe inflation is falling to 0.7%
    With QE in UK inflation is rising though 5%

    Conclusion>>>> Printing funny money stokes inflation.
    Well I never.

  • rate this
    +46

    Comment number 76.

    If the recovery depends on plebs like me spending then they're in real trouble. Rising living costs v static wages means I have less cash to spend on discretionary purchases and I don't see the situation changing any time soon. That's what happens when you allow wealth to aggregate to the 1% - what happened to the much vaunted trickle down effect? Big business can make stuff but we ain't buying.

  • rate this
    +26

    Comment number 84.

    I see that Twitter has opened on the Us stock market at a pretty phenomenal valuation. As I understand it, the valuation of Twitter, Facebook,Google etc are all based on making money from advertising. But surely there must be a limit to the total advertising budget when spread over the internet,Tv and newspapers etc, So does this mean that we can expect some pretty spectacular falls to come?

  • rate this
    +22

    Comment number 31.

    People in Greece aren't holding off from buying goods because they are waiting for a bargain, they are holding off because they have no money. Greece has it's hands tied because it's part of the Euro and is being controlled by a troika of EU bureaucrats.

  • rate this
    +19

    Comment number 39.

    Why is our inflation rate 4 times higher than europe ? Am I missing something . Deflation is not going to happen in the UK. Why is our inflation rate twice that of the USA are we on another planet ? The BoE works hard to generate inflation and is doing a good job.

 

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