Sub-zero inflation

January 7, 2015

A sign announcing a discount is pictured at an Electroniki retail chain shop in Athens

Following a dramatic fall in the price of oil, now down at $50 per barrel from above $115 in the middle of last year, euro zone inflation figures for December are likely to turn negative for the first time since 2009.

The consensus forecast is for a -0.1 percent reading.

For much of the world, the greater disposable income for consumers and companies from tumbling energy prices should act as a fillip to growth but in a region fearing a slide into Japan-style deflation it’s much more of a double-edged sword.

Falling prices would make a European Central Bank quantitative easing government bond-buying programme very hard to argue against and it could well come as soon as a Jan. 22 policy meeting. The euro has hit a nine-year low against the dollar in anticipation.

ECB President Mario Draghi upped the ante last week, saying the risk of the ECB failing to meet its price stability goal had risen. That sounds dry but the central bank has spent its entire existence up to now saying it would deliver price stability.

Draghi has made plain a minority of opponents on the Governing Council will not stop him launching QE. The question is whether he can institute an unlimited programme or whether the likes of Bundesbank chief Jens Weidmann will succeed in limiting its scope.

The latest talk is the ECB could require countries such as Greece or Portugal to set aside money to cover potential losses from any bond-buying, putting the risk on national central banks rather than the ECB and almost certainly limiting the amount of bonds that could be bought in the process.

That is unlikely to revive a moribund euro zone economy.

A report in Dutch newspaper Financieele Dagblad on Tuesday said the ECB is looking at three options:
– Buying government bonds itself in proportion to each member state’s shareholding in the central bank;
– Buying only triple-A rated government bonds, driving their yields down to zero and below in the hope that would push investors into buying riskier debt;
– Making national central banks do the buying.

Reuters has reported similar from sources. Options two and three would disappoint the markets but would be much more acceptable to Germany. The ECB has its mid-month meeting today. There will be no announcement afterwards but all this will be up for discussion behind closed doors.

German Chancellor Angela Merkel will visit London for talks with David Cameron, ostensibly to discuss her agenda for Germany’s G7 chairmanship in 2015. Russia/Ukraine will doubtless be discussed but, presumably, how to keep Britain in the EU will dominate proceedings.

Having talked about limiting immigration within the EU, Cameron rowed back considerably late last year and turned his fire instead on welfare payments to incomers after being told by Berlin and Brussels that freedom of movement was sacrosanct within the EU.

Merkel wants Britain to remain part of the bloc and will bend as far as she can to accommodate Cameron, who has pledged to renegotiate Britain’s EU obligations and hold an In/Out referendum in 2017 if he is re-elected in May. But that may not be far enough to enable the UK premier to be able to claim a new relationship with Europe.

One stumbling block is Britain’s apparent insistence that EU treaty change will be needed to accommodate its demands. Berlin does not agree and EU diplomats say there is a) no appetite for that and b) not enough time, even if there was the will, to conclude one in two years to meet Cameron’s timetable.

Merkel and Cameron have released a joint statement saying more needed to be done to make the EU more stable and competitive, and that they hoped to seal an EU/U.S. free trade deal this year – an indication that there is common ground, if not necessarily where Cameron needs it politically.

French Economy Minister Emmanuel Macron put the onus on Germany, saying it must invest more while France must accelerate economic reforms. On that, Cameron would concur. Merkel will meet French President Francois Hollande in Strasbourg on Sunday where Greek elections, and how to keep the country in the euro zone, are likely to be high on the agenda.

Ireland is preparing to kick off 2015 with a 7-year syndicated bond that sources said could cover up to a third of its planned issuance for the year.

Romania’s central bank meets with a majority of analysts expecting it to cut interest rates by another quarter point to a record low 2.5 percent.

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