Eurozone has officially slipped into deflation, December 2014 prices were 0.2pc lower than a year earlier. January has shown a deeper slide of 0.6pc as compared to January 2014. Most of the general public believed that the ECB was going to launch its multi-billion Quantitative Easing programme in one of its next meetings. However, German government bonds still decreased in yield as investors kept looking for a safe haven for their money. The 10-year yield has touched the lowest mark since 1989.
Additional to problems with price deflation that have been coming for some time now, low oil prices work to the opposite of ECB’s wishes. Central Banks of many developed countries will now have to face the problem of deflation risks due to a long-lasting decrease in oil prices. Canadian CB expects its inflation to briefly go into the negative zone the coming spring, although not long enough to constitute a solid case of deflation.
European case is harder – deflation is already there. The big question right now is whether the Quantitative Easing can help in bringing positive inflation back. Clearly, ECB hopes it will. This week it unprecedentedly announced its plan to go through with its Quantitative Easing programme of €1,1 trillion. They published the 17 pages summary of its last rate-setting meeting as a clear sign to be more open, a trend now observed across most of the major central banks. Perhaps, a strong and credible message that promises cheap money in the next few years will help to boost investors’ confidence.
So what’s the plan?
The programme is planned up until September 2016 with a hope to accelerate the impact of the Quantitative easing that has already been implemented in smaller steps. One big problem, however, is the plan to purchase government bonds in large amounts. The treaties that founded the EU prohibit ECB from financing governments, and what Mario Draghi has planned will surely test that idea. Historically, Germany would be strongly against such moves, since many governments will try to use this opportunity to overspend and increase competitiveness of their own economies. The question is whether the biggest decision-maker in the Euro area is willing to cope with all the risks created by a multi-billion government debt purchases in hopes to strengthen the Euro and bring inflation above zero. This is indeed likely, given the continuing Euro crisis. Of course, there is good news – such as Lithuania joining starting this year, but there is bad news as well. Recent debt talks with Greece have failed and financial specialists all across EU are asking for an exit plan in case no agreement will be made. Even the euro-optimists fear the extent to which such a scenario could harm the Eurozone both economically and politically.
“Even the most ardent euro admirer must concede that the probability of countries leaving or the breakup of the euro zone is no longer zero.” – Mark Cliffe, the chief economist of ING Bank, said
There is an additional fear that the Quantitative Easing by ECB will not be as successful as QE by FED or BOE. The concept behind the programme is not new like it has been when FED introduced it, so it will not come to the market as a full-blown shock. Quite likely, economic agents will have anticipated the effects of the programme before its start and the resulting change to inflation rates will be observed during the very few month of massive securities purchase. However, unanticipated moves, like a negative interest rate, which ECB was first to ever implement, did not make much change either.
Theories aside, not much is clear as to the future of the Euro. Markets are constantly changing direction as Greece talks advance. While ECB is trying to make a stronger than ever commitment to stabilize the inflation, doing so becomes increasingly difficult because the subject of the commitment itself is very keen to change.