ECB at risk of missing its 2% inflation target

The risk has increased that the European Central Bank won’t get inflation back up to where it wants, the bank’s chief economist said yesterday, pledging to beef up its anti-deflation asset-buying programme if necessary.

Peter Praet, who is also a member of the ECB’s executive board, told reporters on the sidelines of a conference in Germany that falling commodity prices and a slowdown in China are hindering the goal of getting inflation back up to around 2%.

It is currently at 0.2%, a trend that has prompted the ECB to start buying €60bn worth of assets a month, mainly sovereign bonds, to combat deflation.

“There should be no ambiguity on the willingness and ability of the governing council to act if needed,” Mr Praet said. “The (asset-buying programme) provides sufficient flexibility to do so in terms of size, composition and length of the programme.”

The bank has already warned that financial developments in China could have a larger-than-expected adverse impact, given Beijing’s prominent role in global trade. China’s growth outlook has declined sharply in recent weeks, potentially increasing the risk for Europe.

The ECB targets inflation at just under 2% and last forecast price growth at 1.8% in 2017, but key inflation drivers have worked against it since the June projection.

Crude oil prices have fallen close to 40% since May, while iron ore prices are near historic lows on expectations that Chinese growth will continue to slow, hitting its lowest level in two decades.

The five-year swap rate, ECB president Mario Draghi’s preferred measure of judging inflation expectations, fell below 1.4% this week before rebounding to 1.6% percent yesterday. Another swap rate has suggested deflation in a year’s time.

“With commodities prices going down and the euro going up, that’s a double whammy, and the ECB has made it clear that it will have implications,” said Veronika Pechlaner, European equity fund manager at Ashburton.

“Rather than doing anything, we imagine Draghi would start talking and try and manage things that way. But he’s got a few options. He could make QE more frontloaded than expected, for example.”

The bank will release fresh inflation forecasts next week and analysts expect a modest cut in the 2017 projection and a larger cut in the more immediate forecasts.

Mr Praet said emerging market growth was weakening and the output gap in some emerging markets was widening, a marginal challenge for the eurozone but still a potential headwind. He added that the ECB would have to weigh the consequences of higher market volatility on financing conditions.

Reuters