Euro zone inflation fall raises expectations ECB will act

Monday 31 March 2014 17.35
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Expectations rise that the ECB will take radical action to stop the threat of deflation
Expectations rise that the ECB will take radical action to stop the threat of deflation
Euro zone inflation falls to 0.5% in March
Euro zone inflation falls to 0.5% in March

Euro zone inflation hit its lowest level since November 2009 in March, a shock drop that raises expectations the European Central Bank will take radical action to stop the threat of deflation.

Annual consumer inflation in the euro zone was 0.5% in March, with the pace of price rises cooling from February's 0.7% reading, the EU's statistics office Eurostat has said.

Economists polled by Reuters had predicted a 0.6% reading - itself worrying for an economy that is barely pulling out of a record-long recession after a crisis that nearly broke up the currency area.

The euro zone is far from the deflation that Japan suffered from the early 1990s, when falling prices weakened demand, leading to wage cuts and even lower prices.

But its low inflation rate is a clear sign of economic fragility in the region.

Inflation has now been in the ECB's "danger zone" of below 1% for six consecutive months, and the flash reading increases the chances the ECB will cut interest rates when its Governing Council meets on Thursday.

Speculation has also grown that it may employ other easing measures such as a negative deposit rate or even US-style bond-buying.

But this year's late Easter, which has delayed the impact of rising travel and hotel prices at a time when many people go away in Europe, could encourage the euro zone's central bank to wait until its June meeting to act.

The ECB, which targets inflation of just below 2%, left borrowing costs unchanged at 0.25% in March and has argued that deflation risks in the bloc are limited. 

Some euro zone members, like Ireland, Cyprus and Greece have experienced falling prices in recent months. For the bloc as a whole, price rises for industrial goods outside the energy sector were very modest in March, a sign demand remains weak.

The International Monetary Fund's top European official said today that the ECB had more room to cut interest rates to counter risks from low inflation, although he said the Fund did not see deflation setting in. 

IMF concern at 'low-flation'

"We are not so much worried about deflation by itself, but we are very worried about what we call 'low-flation'," said Reza Moghadam, Director of the IMF's European Department.

"There is more room for further (ECB) easing, not least because inflation is under control."

ECB President Mario Draghi suggested after the ECB's March meeting that the bank will either do nothing or take bold action should the outlook deteriorate.

He has also said the bank has been preparing additional policy steps to guard against possible deflation, and that the longer inflation remained low, the higher was the probability of deflationary risks emerging.

The relentless weakening trend may focus minds, especially after the head of Germany's powerful central bank came out to discuss some of the bolder options in more detail, for example pumping more money into the economy via a bond-buying programme. 

One factor that may temper the ECB's response is a sense among economists that inflation has hit bottom and will rise in the coming months.