European Central Bank facing spectre of deflation

As European Central Bank policy makers gather for their first meeting of 2015, the backdrop is a 0.2% annual drop in consumer prices, the first in more than five years.

For ECB president Mario Draghi, who wants to open the money tap, the data may push the central bank closer to buying government bonds to revive growth and inflation.

ECB officials are working on a plan to purchase sovereign debt to prevent a deflationary spiral of falling prices and households postponing spending, a risk Mr Draghi has said can’t be “entirely excluded.”

In addition to moribund growth, the region risks being further unsettled by elections in at least three countries and mounting concern about the single currency.

“Hello deflation,” said Holger Schmieding, chief economist at Berenberg Bank in London. “Even if we do not share the widespread concerns about dangerous deflationary dynamics,” the ECB is “miles away” from its goal near 2%, he said.

A separate report showed unemployment remained at 11.5% in November. Joblessness in Italy rose to a record 13.4%. German unemployment, calculated under a national measure, fell to 6.5% in December, the lowest in more than two decades.

The last time the eurozone’s inflation rate went negative in 2009, the economy was struggling to recover from the recession that followed the collapse of Lehman Brothers.

This time, the decline was partly driven by sluggish growth and a drop in crude oil prices of about 50% in the past year. ECB officials have taken different approaches on the impact of plunging oil prices. While Mr Draghi has warned of a dis-anchoring of inflation expectations and signaled support for QE, Bundesbank president Jens Weidmann favours not acting now, arguing the drop could be a “mini-stimulus package.”

Central bank staff have worked on QE proposals in the past two months, and Dutch newspaper Het Financieele Dagblad reported this week governors may be offered three options at their January 22 meeting.

“According to the ECB’s own logic, with sub-zero inflation, no sign of a material pickup on the horizon, and inflation expectations de-anchoring, there is a compelling case for further monetary easing,” said Teunis Brosens, an economist at ING in Amsterdam. “The question no longer seems ‘if’ the ECB will announce QE, but ‘how’ it will be tailored.”

Since June, the ECB cut interest rates twice, offered cheap loans to banks to jumpstart lending and started a purchase programme for asset-backed securities — a move Mr Weidmann and Germany’s Sabine Lautenschlaeger opposed.

“If you look at past experience we’ve taken major monetary-policy decisions in a situation where there was no unanimity,” Mr Draghi said. “So this is what we have to keep in mind.”