ECB ‘alarm bells ring’ at inflation fall

An unexpected drop in eurozone inflation raises pressure on the ECB to consider fresh policy action next week to counter deflation risks and support a weak recovery that may be running out of steam.

Inflation slowed this month to 0.7% from 0.8% in December, confounding market expectations for a rise to 0.9% and matching a low hit last October. The ECB responded then by cutting its interest rates to record lows.

The latest weakening of price pressures took the inflation rate further below the ECB’s target of just under 2% and will fan investor concerns that deflation may be gripping the 18-member bloc as it starts to exit a sovereign debt crisis.

The data would “set alarm bells ringing at the ECB,” said Commerzbank economist Peter Dixon. He added: “With some of the sentiment numbers in the course of recent weeks having beaten expectations, I don’t think it is going to be time next week for the ECB to press that panic button”.

A survey released last Thursday showed the eurozone’s private sector started 2014 in much better shape than expected, with stronger growth across the region marred only by a continued downturn in France.

The ECB’s conundrum is complicated by a sell-off in emerging markets that risks pushing up the euro’s exchange rate — a development that would keep downward pressure on prices and could snuff out the robust start to 2014

ECB policymakers are to meet next Thursday.

Highlighting the bank’s capacity to act if it wants to, executive board member Benoit Coeure said central banks have tools available to lift low inflation back to target, even when interest rates are at zero.

“There are instruments that could be used in the event of downward risks to medium-term price stability, even if the nominal interest rate is constrained by the zero lower bound,” Coeure said.

After their January policy meeting, ECB president Mario Draghi set out two scenarios that could trigger fresh policy action: a deterioration in the medium-term inflation outlook and an “unwarranted” tightening of short-term money markets.