European Central Bank Tackles Deflation Risks in Europe

CEIC WorldTrend Data Talk - June 12, 2014 - On 3 June 2014, Eurostat announced that harmonised consumer price inflation slipped in May 2014 to an average of 0.5% year on year (YoY) across the euro area (EA), symbolizing increased deflation risk in spite of improving output growth. The financial markets reacted negatively and the MSCI Index for the bloc fell by 2.40 percentage points (pp) on the day of the announcement, and by a further 0.45pp the following day in anticipation of the ensuing interest rate cut by the European Central Bank (ECB). The threat of possible deflation came at a time of slowing money supply growth and weakening commodity prices. Commodity price indices compiled by the Commodity Research Bureau (CRB), S&P and Dow-Jones-UBS all fell in May, by 7.67pp, 3.66pp and 3.27pp, respectively, from their April values. The high unemployment rate of 12.05% across the region is a symptom of the weak demand in the EA and further threatens to exacerbate low inflation by curbing private consumption. The decline in money supply growth, in spite of already loosened monetary policy, shifts attention towards economic agents' sentiments. Sentiments were already on a negative trajectory even before the latest inflation figures and ECB's intention to act became known. The EA Sentix economic indicator, published in the beginning of May, reflects rising investor confidence in the present economic situation from 5.75 to 7.5 points, but a decline in confidence for the next six months from 22.75 to 18.25 points. The results of the quarterly Ifo Institute's Western Europe economic outlook survey, conducted among economic experts, display similar trends. According to the Ifo data for the second quarter of 2014, the present economic climate is favourable, with slight improvements in perceptions of capital expenditure and private consumption, by 0.6 points and 0.4 points, respectively, compared to the previous quarter. However, concerns about insufficient demand, high unemployment, unfavourable inflation, public deficits, foreign debts, inefficient government policies and capital shortages, among others, still seem to haunt experts across the region, suggesting a difficult economic climate ahead. While six-month expectations of the region according to both surveys remain in the positive zone, which is over zero points for Sentix and over 5 points for Ifo, the negative perceptions of all these factors can provide clues on the fragile economic dynamics. Other advanced economies seem to be doing better than the EA. North American economies improved rapidly during the last quarter of 2013 and the first of 2014. Indeed, the USA and Canada have shown higher real GDP growth rates of over 2%, compared to the EA's 0.45% and 0.89% for Q4 2013 and Q1 2014. Unemployment rates for these two countries have also fallen to 7.35% and 7.08% respectively in 2013, and are expected to decrease further in 2014. Recovery in the UK also seems to be more robust, with real GDP growth of 3.12% YoY for the first quarter of 2014 and the unemployment rate decreasing by 0.4pp since December 2013 to 6.8%. Inflation has been at the healthier level of around 2% for the past two quarters in these countries. In response to the threats looming within the EA, the ECB became the first major central bank to adopt negative deposit rates. It also launched a EUR 400 billion liquidity scheme to spur commercial bank lending. The Euro reacted fleetingly to the news, with both the Nominal Effective Exchange Rate and the spot rate against the US Dollar depreciating momentarily on the day of the decision. Unlike financial markets, which grew according to the MSCI EA Index, investor's sentiments continued their negative trend after ECB's interest rate move, with the Sentix measuring fast deterioration in perceptions of the "present situation" in June reaching 0.25 points, coupled with a decline in future expectations at 17 points in a survey conducted just after the ECB's press conference. While the latest measures are no doubt unprecedented for the ECB, it remains to be seen whether these will be successful in tackling weak demand, easing risk aversion within the banking sector and lifting deflationary pressures. By Hristo Nikodimov - CEIC Analyst Discuss this post and many other topics in our LinkedIn Group (you must be a LinkedIn member to participate). Request a Free Trial Subscription. Back to Blog
12th June 2014 European Central Bank Tackles Deflation Risks in Europe

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