With Deflation Looming, the ECB is Expected to Do Nothing Thursday

by on April 1, 2014 1:56 pm BST

The European Central Bank (ECB) President Mario Draghi may not be concerned by deflation, but the data is pointing to further slowdown of inflation within the eurozone. With this potential looming, the ECB is expected to hold where they are; but, do not worry! The ECB will likely to repeat their haphazard statement that the central bank will be ready to act, if need be.

Last week, market participants have seen consumer prices tick lower in Germany, Italy and Spain, all under .5 percent. Spain saw the largest contraction of consumer prices in nearly five years, and yesterday’s eurozone consumer price index (CPI) year-over-year estimate contracted further. Economists were expecting .6, a drop from the revised downward figures of .7 percent. However, it came in at .5 percent, dropping two-tenths (as forecasted in the EURUSD weekly outlook). This marks the half-year of sub-one percent inflation.

Thursday’s rate decision and press conference is likely to be humdrum, as usual. The ECB will be contributing the softer consumer prices as a temporary reaction to energy and food prices. A small fraction still believe negative deposit rates could be in the mix as bank lending contracts further, as banks (much like in the United States) sit on cash.

In a world of central banks actively seeking out inflation and easing measures, the ECB has always remained less enthusiastic about doing the same. As a result, the euro has remained quite elevated against major peers given their current economic conundrum. The euro has gained 7.38 percent against the greenback within the last year. Draghi has stated that as inflation weakens, the elevated euro will become a problem.

The negative deposit rates, which act adversely for banks that hoard cash, could help taper the euro. However, Finland’s Governor Erkki Liikanen said that this “isn’t any longer a controversial issue,” which leads me to believe it would have a longer-term effect on the currency’s exchange rate.

The ECB remains on the fence that there are plenty of tools in their toolbox, but it is likely that these tools will all be used as a last resort. Marco Valli, economist at Unicredit, said “the bar for outright government debt purchases remains very high: they will be the weapon of last resort to be deployed only if full-blown deflation were to hit.” That could be sooner than later, given the trend.