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So far the ECB is not responding to ultra-low inflation readings – Sober Look

This is a syndicated repost courtesy of Sober Look. To view original, click here. Reposted with permission.

The Euro area inflation indicators are pushing into dangerous territory. The core CPI measure in particular is trending sharply lower. The ECB has so far been taking a “wait and see” attitude, though some on the Governing Council are apparently getting concerned.

Chicago Tribune: – Core inflation, which strips out volatile costs like food and energy, hit a record low of 0.7 percent.

The readout will heighten concerns at the ECB about entrenched price weakness taking hold, though strong company activity towards the of last year will give them some comfort.

“Obviously they are worried, but it’s not significantly lower than it was a month earlier,” Anders Svendsen at Nordea said. “I don’t think it’s enough to prompt a new rate cut but I do think it’s enough to keep them dovish and ready to act.”

 

Of course it’s no longer about lowering the overnight rate. Given the persistent credit contraction in the euro area (see post), there is pressure on the ECB to add liquidity to the banking system by potentially providing another round of LTRO financing. The current LTRO balances are nearly half what they were after the last 3-year financing program was offered in 2012.

€ million  (source: ECB)

But many analysts believe the ECB will be on hold for some time because of seeming economic improvements in the Eurozone periphery (see chart below) as well as stronger data out of the US.

Source: Markit

There is some concern, paticularly in Germany that if the ECB’s policies diverge from the Fed’s, the euro could weaken significantly – potentially causing prices to rise more than desired. Germany’s traditional fear of inflation and unease with unconventional tools seem to have permeated the ECB’s thinking (particularly now with Ilmars Rimsevics joining the Governing Council). Doing nothing however is a risky policy because ultra-low inflation and weak credit conditions are a recipe for Japan-style deflationary trap (see story).

 

SoberLook.com

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