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Last updated: June 3, 2014 7:54 pm

Eurozone deflation fears add to pressure on Draghi

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Headquarters of the European Central Bank in Frankfurt©Reuters

Eurozone inflation fell unexpectedly to 0.5 per cent last month, intensifying pressure on Mario Draghi, president of the European Central Bank, to act against the rising threat of deflation.

The inflation reading is well below the ECB’s target of just under 2 per cent and on a par with March, when it hit its lowest level since autumn 2009.

The likelihood of looser monetary policy, including a radical move to cut one of the central bank’s key rates below zero, has significantly increased ahead of Thursday’s ECB vote. Mr Draghi is also expected to announce proposals to help credit-starved small businesses.

Hervé Amourda, economist at Société Générale, said the inflation reading “strengthens our call for bolder action from the ECB”.

The mood in Frankfurt contrasts with the debate in the UK, where the Bank of England has started to discuss raising rates after signs the British recovery has gained traction.

The eurozone economy barely grew in the first quarter and the latest disappointment on inflation will stoke concerns, expressed last week by Mr Draghi, of a negative spiral of subdued price pressures and tight credit conditions.

Such a sequence of events could derail the region’s fledgling recovery by destroying demand and raising debt burdens in the bloc’s periphery.

Much lower-than-forecast German inflation in May has already toughened the challenge faced by weaker member states, which are attempting to match the levels of competitiveness seen in the bloc’s economic powerhouse in part through divergences in inflation rates.

Large-scale asset purchases, known as quantitative easing, are not expected this month. But with the ECB set to exhaust all of its conventional tools to fight deflation, analysts are asking whether Mr Draghi will signal that the central bank is prepared to go further.

Ken Wattret, economist at BNP Paribas, said there was a high chance of Mr Draghi strengthening his rhetoric on Thursday afternoon: “Even if the ECB is reluctant to deliver QE at this point, persistent downward surprises on inflation make a strong case for its communication to take a clear step towards it.”

With so much of eurozone inflation linked to the strength of the euro, some analysts
think the more hawkish members of the governing council will try to hold out on asset purchases until the US Federal Reserve begins to debate raising rates.

Talk of rate rises in the US “should weaken the euro against the dollar”, said Jörg Krämer, chief economist at Commerzbank, and “close the eurozone’s window for QE”.

The Fed is expected to end its asset purchases in the autumn, but most think it will only raise rates towards the middle of 2015. The euro fell against the dollar after publication of the inflation figure, but by late Wednesday afternoon in London was up 0.2 per cent at $1.3623.

May inflation was expected to be broadly in line with April’s 0.7 per cent. Some of the unexpected fall was down to lower food prices, which were partly the result of a mild winter.

“If you are a glass half-full person you take comfort from the fact that the collapse in food inflation is largely responsible for the slide in headline inflation, and that this trend could soon reverse,” said Richard Barwell, economist at RBS. “If you are more pessimistic you worry that perceptions and perhaps expectations of inflation are particularly sensitive to food prices.”

Core inflation, which excludes more volatile prices for goods like food and energy, also fell to a multiyear low of 0.7 per cent, from 1 per cent.

Separately, Eurostat, the European Commission’s statistics bureau, reported that unemployment in the eurozone remained close to its record high in April.

Unemployment fell only slightly, to 11.7 per cent from 11.8 per cent in March.

The jobless rate varies wildly across the region. In Austria and Germany, only around 5 per cent of those that want work are without it. In Greece and Spain, more than a quarter of those in the labour market are without a job.

Additional reporting by Delphine Strauss

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