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Inflation in Euro Zone Falls to 0.5% Another Worrisome Drop in Euro Zone Inflation
(about 9 hours later)
FRANKFURT — Inflation in the euro zone slowed to an annual rate of just 0.5 percent in March, lower than expected, according to an official estimate released on Monday, as prices remained subdued in Germany. FRANKFURT — A drop in euro zone inflation, to the lowest rate since 2009, has raised new questions about whether its economy is stuck in doldrums that could last for years and, if so, whether the European Central Bank has the will and the wherewithal to do anything about it.
Economists had been expecting prices to rise at an annual rate of 0.6 percent, from a rate of 0.7 percent in February. A further decline had been expected after Germany, which has the largest economy in the euro zone, reported on Friday that prices there rose 0.9 percent last month, less than analysts had forecast. Official data Monday showing that annual inflation in March was just 0.5 percent, according to preliminary estimates, inflamed an issue that had already polarized economists and policy makers.
The “core” inflation rate, which strips out volatile energy and food prices, rose at a slightly more robust 0.8 percent rate, but that was down from a 1 percent rate in February. Energy prices were a drag on the overall inflation rate, Eurostat noted, dropping 2.1 percent in March from a year earlier. Some say there is nothing to worry about, that slumping prices in countries like Greece and Portugal are part of a necessary correction in competitiveness.
The data released on Monday were sure to reignite the debate about whether the euro zone faced a risk of deflation, and to put pressure on the European Central Bank to take action when it meets on Thursday. Another camp, though, sees Europe slipping over the precipice of deflation, an especially pernicious species of economic woe because it is so hard to reverse. When prices are falling on a broad front, consumers delay making major purchases because they expect prices to drop even more. Companies suffer declines in sales and are unable to invest or create jobs.
Mario Draghi, the president of the European Central Bank, has said that countries in which inflation is weakest needed to lower prices, so that their exports can be more competitive in world markets. Prices in Spain, which has one of the weakest economies in the euro zone, unexpectedly fell by 0.2 percent in March. The new data add ammunition to those who are pressing for the European Central Bank to take action to try stimulating the euro zone economy. Still, few experts expect the central bank to do so this week — whether because the evidence of deflation is still not suitably compelling, or because the bank’s remaining weapons are too limited to risk firing too soon.
Mr. Draghi has also said that much of the decline in inflation comes from lower energy prices. The situation will have to get much worse before the E.C.B. will take that risk, Carsten Brzeski, senior economist at ING Bank, said Monday. “Is the situation bad enough? We don’t think so.”
But the argument becomes more difficult to make when countries like Germany, where unemployment is low and growth is solid, are also seeing very low price growth. The European Central Bank aims to keep inflation just under 2 percent, a level that even according to its own estimates will not be reached until 2016. Members of the too-soon-to-panic camp point out that much of the unexpectedly low inflation reported by the European Union statistics office is a result of falling energy prices, rather than slow growth.
Economists are divided over whether deflation is a real risk in the region. Some consider deflation warnings overblown, while others say that the euro zone is in danger of experiencing the same prolonged stagnation seen in Japan, which has been trying to escape deflation for much of the past two decades. Some analysts even dismissed the drop in annual inflation in March, which compared with a rate of 0.7 percent to March 2013, to the so-called Easter Bunny effect. Easter is when travel companies typically raise their prices for package tours, a component of the consumer price index. Easter comes in April this year, meaning any such price increase also come a month later, as the holiday was in March last year.
Deflation is considered an especially pernicious economic condition. When prices are falling, consumers delay making major purchases because they expect prices to drop even more. Companies suffer declines in sales and are unable to invest or create jobs. Corporate revenues and wages fall, making it more difficult for people and companies to repay their debts. Even people who do not expect deflation, though, warn that very low inflation has other ill effects on a region still emerging from a debt crisis.
As Japan demonstrates, deflation is very difficult for policy makers to correct. Subdued inflation means that governments, businesses and individuals in the vulnerable countries will find it even more difficult to repay their debts. A little inflation is good for borrowers, because it chips away at the overall debt burden.
The European Central Bank’s benchmark interest rate is already at a record low of 0.25 percent and it has few easy options left to stimulate growth. But most analysts do not expect the central bank to take action Thursday. “For me that’s the biggest concern,” said José Manuel Campa, former secretary of state for finance in Spain and now a professor at the IESE Business School in Barcelona and Madrid. Low inflation “just puts a much larger burden on the adjustment that needs to take place,” he said.
“We still think that the ECB’s preferred next policy option is to do nothing,” Carsten Brzeski, an economist at ING Bank in Brussels, wrote in a note to investors. Economists had been expecting prices to show softening in March, after official data last week showed inflation in Germany at an unexpectedly low annual rate of 0.9 percent. In Spain, prices fell 0.2 percent. But analysts were surprised how much the rate fell.
Mr. Brzeski said that the E.C.B. would continue to offer assurances that it remains ready to take action if necessary. “The ECB will continue talking the talk in order not to have to walk the walk,” he wrote. The central bank, which meets to discuss monetary policy on Thursday, now faces intensified criticism that it is not fulfilling its mandate to keep inflation below, but close to, 2 percent. Economists consider a little inflation to be a good thing, in part because it creates a buffer against deflation.
If inflation was as far above the 2 percent target as it now is below it, critics say, the central bank would have long ago raised interest rates to slow the economy.
“The E.C.B. should be concerned that they are losing their credibility,” Mr. Campa said.
The problem for the central bank and its president, Mario Draghi, is that it has run out of easy options to influence the economy. The benchmark interest rate is already at a record low of 0.25 percent. The next step would have to be more radical and risky, like huge purchases of government or corporate bonds to pump money into the economy.
The Federal Reserve has used such quantitative easing to stimulate growth in the United States. But in the euro zone a similar strategy is fraught with problems. The euro zone does not have an equivalent to United States Treasury securities or a unified bond market. The central bank would have to buy bonds or other assets in the 18 countries that belong to the euro zone. Its decisions about how to distribute the purchases could easily expose the bank to charges it was favoring one country over another.
Measures like quantitative easing, said Mr. Brzeski, the ING economist, “are still controversial and they are not easy to use.” More likely, he said, is that the central bank will focus on how much of the slowdown in inflation was a result of falling energy costs, and not a sign of economic malaise.
The core inflation rate, which strips out volatile energy and food prices, rose at a slightly more robust 0.8 percent rate in March. Still, that was down from a 1 percent rate in February. Energy prices dropped 2.1 percent in March from a year earlier, according to Eurostat, the European Union statistics office.
Mr. Draghi has said low inflation is concentrated in crisis countries where falling prices are welcome and necessary to regain competitiveness on world export markets.
But that argument becomes more difficult to make when countries like Germany, where unemployment is low and growth is solid, are also seeing very low inflation.
Mr. Brzeski predicted that the central bank would continue to offer assurances that it remained ready to act if necessary, while hoping that inflation picked up in coming months.
Recently even the German central bank, the Bundesbank, which is notoriously vigilant against inflation, has softened its tone. Jens Weidmann, the Bundesbank’s president and a member of the E.C.B. governing council, said recently that he did not rule out some form of quantitative easing as a last resort.
Such talk is intended to demonstrate E.C.B. resolve, and speech alone is likely to be the preferred policy for the time being. “The big balancing act for the E.C.B. right now is getting this message across without doing anything,” Mr. Brzeski said, “and keeping their fingers crossed.”