ECB ready to take action

The European Central Bank is ready to take action to combat low inflation in the continent in an attempt to help the economic show stronger growth.

Brian Blackstone and Marcus Walker had this story in the Wall Street Journal:

The European Central Bank is poised to act against very low inflation after months of delay, amid mounting evidence that weak prices are undermining the euro zone’s recovery from its debt crisis.

Tuesday’s report showing inflation in the 18-country region softened to 0.5% last month—a four-year low—underscored the challenge facing the ECB as it prepares for a policy-setting meeting Thursday. Inflation is far short of the central bank’s target of just under 2%, even as price increases move steadily toward normal levels in other major economies, including the U.S

A European economic recovery that appears stuck in low gear is contributing to widespread political discontent, evidenced in the voter backlash against the political establishment in several countries in the recent European Parliament elections.

With governments constrained by high debts, the central bank is one of the only institutions that can still act to give the currency bloc a lift. However, it has struggled to find the right response.

Reuters had this story by Martin Santa outlining the current state of the Euro zone economy:

Euro zone price inflation fell unexpectedly in May, increasing the risks of deflation in the currency area and all-but sealing the case for the European Central Bank to act this week.

Annual consumer inflation in the 18 countries sharing the euro fell to 0.5 percent in May from 0.7 percent in April, the EU’s statistics office Eurostat said on Tuesday.

Economists surveyed by Reuters expected inflation to remain at April’s level.

“The ECB hardly needs any more reason to deliver a major package of stimulative measures at its June policy meeting on Thursday to counter the risk of prolonged very low inflation turning into deflation,” said Howard Archer, chief European economist at consultancy IHS Global Insight.

The New York Times story by Liz Alderman had these details about the moves the central bank might is considering:

The situation has grown so alarming that the central bank is expected on Thursday to take extraordinary measures to try to stimulate the economy. Not only is it expected to cut its main interest rate for the first time since November 2013, but analysts also anticipate it will start charging commercial banks to keep money in its vaults — the imposition of so-called negative interest rates — whose consequences might be hard to predict.

The central bank’s moves would be aimed at preventing low inflation from becoming outright deflation: a tailspin of falling prices and wages from which it can be difficult for economies to recover. In such an environment, consumers and companies may delay spending in anticipation that prices will fall further, which would only exacerbate the economic problems.

That problem plagued Japan’s moribund economy for two decades, and officials are only barely starting to halt the price declines.

After years of a debt crisis, a number of countries in the euro zone are grappling with the effects of economic lethargy. At clothing stores, cellphone companies and factories making items as disparate as aluminum and tiles, owners faced with slumping demand have been pressured to cut their prices. In hard-hit countries, wages have also fallen sharply from precrisis levels.

Especially in the most fragile economies, the dynamic is crimping growth and dampening government efforts to pay down debt, regain competitiveness and tackle unemployment.

Emma Charlton and Anchalee Worrachate wrote for Bloomberg that bond prices are signaling that investors want the ECB to do more than it already has thus far:

While bond, currency and derivative markets show an abatement in the contagion that began in Greece in 2009 before engulfing Spain and Italy, a closer look reveals high debt and deficits that have yet to be addressed, unemployment near record levels and a banking system still to be fixed.

ECB policy makers will share their outlook in two days, when they probably will lower the 18-nation currency bloc’s official rate toward zero and take the deposit rate negative for the first time.

“The outright level of yields is suggesting an incredibly weak outlook for growth,” Russell Silberston, a London-based money manager at Investec Asset Management, which oversees $110 billion, said in a May 30 phone interview. “It’s a powerful signal telling you policy is too tight and that there’s complacency toward the risks. Not a great deal has been solved. We’ve still got bank stress tests to come, too low growth and too low inflation.”

Speculation the ECB will provide more stimulus pushed yields on euro-region sovereign debt to a record-low 1.43 percent on May 30, according to Bank of America Merrill Lynch’s Euro Government Bond Index. Draghi said May 8 the Governing Council is “comfortable” taking action to boost consumer-price growth. Data today showed inflation cooled to 0.5 percent in May, well below the ECB’s aim of keeping it just under 2 percent.

Yet there is little evidence that record-low borrowing costs and bond yields are feeding through to the economy. While the central bank’s lending survey showed conditions for new loans stabilized in the first quarter, lending to companies and households has been contracting for almost two years.

The ECB has much work to do to regain the confidence of investors as well as to combat deflation. While it might need to raise wages and stimulate spending, the Eurozone also should work to regain the confidence of investors. There are many moving parts, but the drag on the economy has been going on since 2009 and investors are only so patient.