Thursday’s news that eurozone inflation came in at a brisk 0% in April was cause for some to celebrate the end of disinflationary pressures across the currency bloc. The fact that, for the first time in four months, prices didn’t fall on average is apparently proof that ECB asset purchases have rescued the region from deflation which, in a world built on debt, is an adversary that must be overcome [14] at all costs. Here’s Bloomberg [15]:
Euro-area consumer prices ended a four-month streak of declines after the European Central Bank started pumping billions of euros into the bloc’s economy through its quantitative-easing program…
The improvement helps ECB President Mario Draghi’s case that large-scale asset purchases have already shown success in averting deflation in the 19-nation economy. Bank lending increased in March for the first time since 2012 and encouraging data from Germany to Spain point to a strengthening recovery even as the Greek crisis undermines confidence.
“The big bad deflationary spiral lasted all of four months,” said Nick Kounis, head of macro research at ABN Amro Bank NV in Amsterdam. “We expect headline inflation to accelerate to above 1 percent by year end as the depressing impact of energy prices fades,” while “core inflation will start to pick up as the effects of the past depreciation of the euro and the recovery of the economy feed through”...
Depressed by oil prices falling almost 50 percent in the second half of 2014, the euro-area inflation rate turned negative in December and fell to minus 0.6 percent at the beginning of the year, matching an historic low. Since then, signs have increased that the region’s flirt with deflation will be short-lived…
A “consistent policy response” allows the ECB to “envisage with confidence that the weak and uneven recovery experienced in 2014 will turn into a more robust, sustainable upturn,” Draghi said in the foreword of the institution’s annual report published last week. “Inflation will return without undue delay to the ECB’s objective of below, but close to, 2 percent over the medium term.”
Meanwhile, Goldman suggests factors beyond falling energy prices may be behind persistently low inflation in Europe…
At the root of the decline in European rates lies a key macro development: in the Euro area inflation has trended lower since 2010 and is now running at very depressed levels. To be sure, low inflation is not distinctive of the European continent. Headline inflation is at least 50% below the respective central bank’s target in an increasing number of advanced economies – a trend which should reverse from next year according to our forecasts.
There has been a common driver of low inflation across economic regions. Crude oil prices have fallen by 60% between June 2014 and March of this year, when measured on WTI expressed in Dollar terms. We estimate that this decline alone has shaved, on average, 80bp off headline inflation in the US, Euro area and Japan over the corresponding period. The negative contribution will extend into the early Summer, before reverting on the back of a combination of base effects compounded by the bounce back in energy prices. As illustrated in Exhibit 7, swings in energy prices have moved the market price of future inflation in both the Euro area and the US…
However, a closer look at the underlying dynamics in Euro area retail prices reveals a more specific problem. The more domestic-led and persistent components of inflation (in the tertiary sector for example) have been on a downward trend since 2010. A comparison with developments in the US on similar components of CPI strengthens the view that disinflation in EMU goes far beyond the impact of lower energy prices, and global disinflationary forces in tradable good prices…
[16]
Interestingly, Goldman also notes that the very structure of the currency bloc may be a contributing factor…
Part of this deeper deceleration in Euro area inflation reflects the external rebalancing taking place among countries that have adopted the Euro. Since the lion’s share of crossborder trade flows is within the monetary union, where by definition exchange rates cannot fluctuate, the adjustments involve relative movements in prices and wages. And dis-inflation has been amplified by the sovereign and banking ‘credit shock’.
...and while both a supply shortage and the combination of negative rates and excess liquidity set the ECB’s stimulus measures apart…
The size of the ECB’s planned ‘money printing’ exercise is comparable to that seen in the US over the Federal Reserve’s three QE programs, and larger than that introduced by the Bank of England, when scaled for nominal GDP. Two key elements make the ECB’s QE ‘unique’. First, in the US, the UK and currently in Japan, the fiscal authority was running large deficits, i.e., issuing more securities, while the central bank was buying public bonds. By contrast, the Euro area has, in aggregate, a small deficit, which means that the ECB is eating into existing holdings of securities. The resulting impact on bond prices is therefore larger, all else equal. Second, flooding the banking sector with excess balances and concomitantly pushing through the negative deposit rate has not been seen elsewhere (in the US, the IOER was increased when QE started).
...the market isn’t buying it…
Yet, the effects on underlying inflation have so far been tepid. What is worrisome is that market participants still do not see consumer price inflation returning to the ECB’s 2% target on a sustained basis, let alone going above it, over any reasonable time horizon. In other words, the Euro area market is priced for a prolonged period of ‘low-flation’...
According to the inflation forward curve, headline CPI will not touch 2% again until 2030.
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And while the bank is ultimately confident that the Goldmanite in charge of the ECB will succeed in driving up inflation over time, the market would be wise to note that the US and Japanese experiences with QE don't provide much in the way of empirical support for that contention, and in fact, as we've shown time and again, QE in fact may be contributing [19] to deflation but don't worry, when the helicopter cash drops begin in order to counter the severe global supply glut and stave off liquidation, then the central bankers of the world will get their inflation — it just won't be the "healthy" 2% they want.
