GUEST COLUMNIST: With confidence deflated in euro area, ECB must provide a stimulus

Mario Draghi this week faces one of the dominant challenges for the euro-area economy in 2015, writes Catherine Bosley

Mario Draghi, president of the European Central Bank, will this week face one of the dominant challenges for the euro-area economy in 2015.

In December, consumer prices recorded the first annual decline in more than five years, amid a slide in the cost of oil, aggravating concern at the ECB that subdued inflation will become entrenched.

With Italy in recession, French momentum lacklustre, and Germany in a weak patch, policy-makers are haggling over a stimulus, as governments drag their feet on economic reforms.

Inflation data, out this week, may tip the scales in favour of large-scale, sovereign-bond purchases when Draghi leads a meeting of the governing council later this month.

Mr Draghi said, last week, that the risk of deflation “cannot be entirely excluded,” while others, led by Bundesbank president, Jens Weidmann, favour holding-off to allow previous measures to take effect.

“Downside surprises on inflation are far from over,” said Jacques Cailloux, chief European economist at Nomura International Plc, in London.

“That’s probably going to be the very important theme for the year.”

German inflation slowed to the weakest in five years, in December, a sign that euro-area prices have started to decline.

The region’s rate fell to minus 0.1%, according to a Bloomberg News survey. That would be the first drop since October, 2009, when the economy was struggling to recover from a slump after the financial crisis. Core inflation is said to have held at 0.7%.

The ECB aims to keep inflation just below 2%, and its chief economist, Peter Praet, said in an interview with Germany’s Boersen-Zeitung, last week, that consumer prices may decline “during a substantial part of 2015.”

Policy-makers’ analysis is complicated by the prospect of renewed political turmoil in Greece, which will hold snap elections on January 25, three days after the governing council meeting.

The vote could deal power to opposition group, Syriza, which wants to abandon the austerity measures and economicchanges linked to bailout agreements.

The euro weakened to its lowest since 2006, yesterday, amid concern that Greece will exit the currency union.

“I don’t think a Greek crisis would be completely isolated,” Alberto Gallo, head of European macro-credit research, at London-based Royal Bank of Scotland Group Plc, said. “This is a make-or-break year for Europe.”

Uncertainty about Greece’s future weighs on a euro-area economy struggling to pick up speed, leaving companies with little pricing power. The ECB forecasts inflation of 0.7% this year, and 1.3% in 2016, with economic growth of 1% and 1.5%, respectively.

“The danger of a deflationary spiral, I don’t see that,” said Holger Schmieding, chief economist at Berenberg Bank, in London. “But, regardless of this danger, with such a slow economy, with a very, very low, core inflation rate, it’s simply right for a central bank to add to stimulus.”

Draghi said in an interview with German newspaper, Handelsblatt, published last week, that while deflation risks are “limited,” policy-makers “have to act against such risk.” Asked how much the ECB might spend on government bonds, he said that it’s “difficult to say.”

ECB executive board member, Benoit Coeure, has said there’s broad consensus among officials for more action.

Staff are preparing a quantitative-easing package for discussion at the January 22 meeting, and more than 90% of economists in Bloomberg’s monthly survey, which was conducted in December, predicted QE will start this year.

“Ultimately, the decision on whether to act or not will depend on the fresh news on the business cycle, and whether there are further negative surprises,” said Anna Maria Grimaldi, an economist at Intesa Sanpaolo SpA, in Milan.

Support for the euro-area economy, which now comprises 19 countries, after Lithuania joined on January 1, may come from a weaker currency and from oil prices that fell almost 50% last year. They could make the region’s exports cheaper and boost consumer spending.

Economic data due today is expected to show confidence improved for a third month, as of December, with unemployment holding at 11.5% in November.

Political uncertainty, both within the euro area and beyond, is among the main threats to growth in 2015.

Russia is headed toward recession and a banking crisis, after the ruble staged its worst annual slide since the nation’s 1998 default. European Union sanctions against the country are increasingly affecting businesses, from Germany to Finland.

In addition to the Greeks, the Spanish and Portuguese will head to the polls this year to pick new governments, while Italy is facing presidential elections, after Giorgio Napolitano said, on New Year’s Eve, that he’ll resign “soon.”

The process will temporarily freeze Italian parliamentary activity, at a time when the country, struggling to emerge from its longest economic recession ever, is under pressure to deliver on reforms.

At his last ECB press conference, on December 4, Mr Draghi said the risks to the outlook were “on the downside,” with confidence and investment threatened by geopolitical events.

Cailloux, at Nomura, says there’s little the ECB can achieve, even with sovereign QE.

“The response, in itself, is unlikely to change the course of inflation dynamics, which are going to be extraordinarily low,” he said.

Catherine Bosley is a reporter for Bloomberg News in Zurich.


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