Draghi has spoken, with his boldest move since taking command

The euro zone patient is still alive but it is definitely not kicking

Fri, Jun 6, 2014, 01:00

Another set of fresh Eurostat figures show that economic growth rose only by 0.2 per cent in the first three months this year and by 0.3 per cent in the wider EU. In spite of all the upbeat talk about the economic turnaround, growth was actually higher in the final quarter of 2014. The euro zone grew then by 0.3 per cent and the EU by 0.4 per cent.

So far, so sluggish. The euro zone patient is still alive but it is definitely not kicking and shows little inclination to do so. On top of all this is a grave new danger as the euro zone drifts towards deflation, something which can be every bit as bad as runaway inflation.

Separate figures out this week put the euro zone inflation rate at 0.5 per cent in May, well under the ECB’s target of “below but close to” 2 per cent. This was down from 0.7 per cent in April and many economists believe it could fall lower still.

Why is this of such concern to ECB policymakers? Although prices are still rising a little in euro, the basic fear is that the expectation of lower promises tomorrow will encourage consumers to delay spending their money. This would further depress demand, damaging companies, magnifying the real burden of public and private debt, and threatening a new wave of bankruptcies after years of grinding recession.

This is something of a nightmare scenario, prompting anxiety that a pernicious self-reinforcing deflationary cycle could lead Europe into a prolonged depression in the mode of Japan. True, Draghi took care yesterday to say the bank does not currently see a deflationary “self-fulfilling negative spiral” in the euro zone. But he expressed concern nonetheless about the persistence of low inflation, indicating that current trends are unsafe.

“As I often said, the longer it lasts, the higher the risks, and that’s what we are reacting to. We are reacting to a risk of a too-prolonged period of low inflation,” he said. “The longer inflation doesn’t go back, the more the governing council is in a watchful position.”

While the ECB has spurned entreaties throughout the crisis to go further, faster in its broader response to the crisis, the bank appears to have concluded in recent weeks that it has reached another moment of truth in the battle to regain the economic initiative.

 

New package

There are several elements to the new package, the first being interest rate cuts. The main rate has been cut from an historic low of 0.25 per cent to 0.15 per cent, ever closer to zero. This will benefit tens of thousands of Irish home-owners who have tracker mortgages, in which the interest rates is contractually tied to the ECB. When the ECB cuts rates, their mortgage rates follow suit.

For all mortgage holders, there was further good news in Draghi’s declaration that an increase in rates set in Frankfurt is not on the horizon.

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