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Deflation fears mount as eurozone price growth falls

Lagarde ECB

Pressure on policymakers to take preventive measures to stimulate the economy and thus cushion the ensuing economic repercussions, posed by the COVID-19 pandemic have in recent months, mounted.

Economic data which typically evaluates recent developments in economic activity and provide guidance to the European Central Bank (ECB), dictating policy actions put forward, deteriorated.

The eurozone, already presumed to be economically weak before the pandemic, is now on the brink of sliding into deflationary territory. The economic disruption brought about by the pandemic and the collapse in energy prices dragged price growth in the bloc to 0.1 per cent in May; the lowest rate since June 2016.

In-line with market expectations, Eurozone inflation in May 2020 took the headline rate to within a whisker of zero, to 0.1 per cent, from 0.3 per cent in April. Notably, having fallen 9.7 per cent in April, energy prices plunged at a faster pace, 12 per cent year-on-year. Food, alcohol and tobacco prices were down 3.3 per cent in May compared with to a 3.6 per cent decline in April. Conversely, the cost of services within the bloc edged higher.

Core inflation which excludes food and energy prices, and tend to face volatile movements, remained steady at 0.9 per cent – a figure whose significance was played down by economists, warning against the limited data the preliminary reading was captured with.

Although the forecast for oil prices suggest a recovery in the short-term, thus alleviating the headline rate by reducing the drag energy prices have posed on the most recent economic data, downward pressure on prices is set to persist, as demand remains weak and unemployment rises.

Should this be the case, and the recovery in oil prices is not sufficient to outweigh the downward pressure on prices, the ECB’s below-but-close to two per cent inflation target will further remain out of reach, keeping pressure on the monetary politician which will be forced to push forward a more pronounced mandate for price stabilisation.

With the economic output set to remain below pre-virus levels for the next couple of years, the Governing Council of the ECB is expected, at least for the foreseeable future to maintain a loose monetary policy stance.

As the governing council is set to virtually convey later on today, expectations for further monetary stimulus are on the rise. Notably, in a survey, Bloomberg found that analysts are widely expecting ECB’s president, Christine Lagarde, to announce a fresh boost to its stimulus efforts, to tackle the economic and financial fallout from the COVID-19 pandemic. The ECB is likely to shrug off a recent ruling by the German constitutional court, which criticised its bond-buying programme, and ramp it up by an additional €500 billion – a figure that would take the ECB’s quantitative easing programme to €1.6 trillion this year.

Should the ECB embark on additional stimulus, and thus fulfil market expectations, Lagarde is expected to reiterate its long-standing message that it cannot deliver an economic recovery on its own.

Undoubtedly, the most recent actions taken by governments, in addition to the push by the European Commission in terms of providing further financial support, were crucial for the recent positive moves within financial markets. However, the psychological aspect of the end consumer in the current unprecedented scenario, is yet to be analysed in the coming weeks. A high level of savings rate would surely be an issue for inflation figures, leaving the ECB no option but to explore other mechanisms to trigger inflationary expectations. Now, more than ever, inflation levels are primarily at the mercy of consumers.

Disclaimer: This article was issued by Christopher Cutajar, credit analyst at Calamatta Cuschieri. For more information visit https://cc.com.mt/. The information, view and opinions provided in this article are being provided solely for educational and informational purposes and should not be construed as investment advice, advice concerning particular investments or investment decisions, or tax or legal advice.

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