Shock low euro zone inflation – what the economists say

October 31, 2013

The slump in euro zone inflation to 0.7 percent in October was a big shock – that figure undercut even the lowest forecast from 42 analysts polled by Reuters.

Here’s what they had to say about what it means.

Generally, they were agreed that such low inflation ratchets up the pressure on the ECB to ease policy further, although some said that October figure probably represents the trough for inflation.

Ben May, European economist, Capital Economics

“The latest euro-zone inflation and unemployment figures will increase pressure on the ECB to take further action to support the economy. Meanwhile, euro-zone unemployment rose by 60,000 in September and falls in the previous months were revised away. Given this, the unemployment rate was 12.2%, unchanged from August’s upwardly revised figure. The latest figures put a dent in hopes that the labour market may have reached a turning point.

“In all, then, the figures provide further signs that inflationary pressures in the region look set to remain weak. Given this and the further rise in the euro, pressure looks set to build on the ECB to loosen monetary policy further.”

Holger Sandte, chief European analyst, Nordea

“In our view, the current reading of 0.7  percent is the low point at least for this year.

“Whether falling inflation is a bad thing for the economy, depends on the reasons and circumstances. For energy importers like the Euro area, lower oil prices mean a lower import bill and more money left to spend. However, the low inflation rate in general (not necessarily the recent drop of the inflation rate) reflects the underlying weakness of the economy and especially the labour market. The drop in inflation alone should not the push the ECB towards a rate cut. In our view, it needs weaker business cycle indicators to make the ECB act. In any case, pressure on the ECB is rising.”

Christoph Weil, European economist, Commerzbank

“This outcome might fuel fears of impending deflation in EMU. We, however, believe that the low rate of inflation is a positive sign, as it is largely due to weak price pressure in the crisis countries. Declining prices in Greece and Spain confirm that companies are using the drop in unit labour costs to improve their price competitiveness.

“We believe that the inflation rate has almost reached its trough. This is what our Inflation Monitor suggests, too. We are not concerned about deflation, i.e. a broad decline in consumer prices.”

Howard Archer, chief UK & European economist, IHS Global Insight

“An inflation rate of 0.7 percent could easily be seen as warranting an interest rate cut in itself, and the rise in unemployment heaps further pressure on the ECB to act, but we doubt that the bank will do so at its 7 November meeting. The ECB will likely limit its action at its November policy meeting to reiterating its forward guidance that it “expects the key ECB interest rates to remain at present or lower levels for an extended period of time.

“However, latest developments reinforce our view that the ECB will end up cutting interest rates from 0.50 percent to 0.25 percent sooner or later. Indeed, we certainly would not rule out a cut in December, although the ECB may hold off acting until the early months of 2014. We suspect that a combination of very low inflation, an uncomfortably strong euro, and a failure of Eurozone growth to gain appreciable momentum will eventually prompt the ECB into taking its interest rate down from 0.50 percent to 0.25 percent.

Annalisa Piazza, market economist, Newedge Strategy

“What will the ECB say about the sharp drop in inflation? We rule out the assessment of risks for inflation (still balanced in Sept) will change next week. That said, the ECB is expected to signal risks stemming from some core components starting to edge lower and the negative effects of a stronger EUR.

“In a nutshell, we suspect the tone of the ECB press conference will be rather dovish next week, with signals of extremely fragile economic conditions and risks of disinflation across all the major EMU economies.”

Jens Larsen, chief European economist, RBC

“The combination of lower inflation, rising unemployment and a stronger euro clearly challenges the ECB’s current stance, where monetary policy is kept accommodative and monetary conditions are supported by forward guidance.

“The weak data at the very least solidifies the consensus that the main policy rates will stay low for a long while yet, but also questions whether a further reduction in rates would not be warranted. For now, we do not expect the Governing Council to go there, but the questions will surely arise what needs to be done to lift inflation in the euro area towards the ECB’s comfort zone.”

Nick Kounis, head of macro research, ABN AMRO

“This raises the question of whether this will prompt a response from the central bank, given that its price stability goal is supposed to be symmetrical. There is certainly a strong case for the ECB to put in place a yet more aggressive monetary easing stance to guard against risks of inflation settling at too low levels.

“However, there seems to be strong resistance in some corners of the Governing Council… Given this, a move at the November meeting is still not probable, but more dovish rhetoric is likely and we do expect the ECB to respond eventually. In particular, we think that the central bank could use its December inflation projections – which for the first time extend to 2015 – to strengthen its forward guidance. ”

Martin van Vliet, senior economist, ING

“With the stronger euro acting as an additional disinflationary force, we would not be surprised if ECB President (Mario) Draghi’s introductory statement next week cites the recent appreciation of the euro as a downside risk to inflation. We also expect him to reaffirm the ECB’s commitment to keep interest rates at record lows for an “extended period”, while keeping the door to a further rate cut or a new LTRO wide open.”

Compiled with Jonathan Cable

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