Home > Euro Area Core Inflation Hits All-Time Low

Euro Area Core Inflation Hits All-Time Low

September 3, 2020 By Mircea Vasiu

Unprecedented low inflation hit the Euro area during the coronavirus crisis and the ECB is facing tough times. The core inflation, the favorite metric for the central bank to measure the change in prices, fell to 0.4% on 0.9% expectations.

It threatens to break below zero into deflation territory, should the ECB not do anything. But what is it supposed to do when the deposit facility rate is already below zero for many years now, and the other two rates, the marginal lending facility and the interest rate on the main refinancing operations, are close to the lower boundary too?

Next Week’s ECB Interest Rate Decision To Bring Volatility on the Euro Pairs

Tuesday’s data may prove to be a game-changer for the monetary policy in the Euro area. The ECB’s price stability mandate means inflation close to the 2% level, not close to zero. In fact, this is one of the reasons why economic consensus agrees with the 2% target as being an appropriate level for sustained economic growth – it is far away from the zero level and not high enough to create hyperinflation.

However at 0.4%, the deflationary danger is real. In other words, it threatens everything the ECB did during the crisis. And it did a lot!

As a result it is pointless to provide businesses cheap loans, households economic support, if spending does not rise. If people keep stashing money away, postponing consumption, a vicious circle puts pressure on the ECB to do more. However, more means more easing or more printing – but that will not change much if, again, the economy is not picking up and households start spending.

Inflation is the metric to watch. When it is falling, like it does, it spells troubles for the currency and for the ECB’s credibility too. If it reverses and moves towards the target, it gives the ECB room to maneuver and to balance its policy so to fit every member state’s need.

Now the ECB feels cornered. It must do more, but the risk is that we will see no effects. On the other hand, if it does not do more, the currency will continue to strengthen.

We have seen the ECB’s desperation this week. Lane, its chief economist, delivered a verbal intervention to steam the Euro’s appreciation as it reached 1.20 against the USD.

This is a rare phenomenon for the ECB – and living proof of the challenges it faces.

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