European consumer prices drop more than expected

Consumer prices fell more than economists forecast in January, underlining the challenges Mario Draghi faces as he seeks to stave off a deflationary spiral. The annual inflation rate fell to minus 0.6 per cent, matching the biggest decline in prices in the history of the single currency. The drop exceeded economists' estimates for a 0.5 per cent slump.

Unemployment fell to 11.4 per cent in December, according to a separate report published Friday.

Sinking prices combined with stubbornly high unemployment led the European Central Bank president to announce a €1.1 trillion stimulus plan last week that centered on government-bond purchases. Even though the size of the program exceeded economists' forecasts, it's still unclear whether it will be enough to return inflation to the Frankfurt- based central bank's goal of just under 2 percent.

“Falling prices today and alarmingly pessimistic expectations of where prices are heading in the future proves beyond all reasonable doubt it was high time to act,” said Richard Barwell, senior European economist at Royal Bank of Scotland Group Plc in London. “Its risky starting QE this late in the deflation game.”

Inflation expectations fell below 2 per cent in August and have dropped further since. Although policy makers including Draghi say they don’t see signs of postponed spending in anticipation of declining prices, the rate may stay negative for a substantial part of the year.

Economic forecasts

Professional forecasters surveyed by the ECB before the QE decision on Jan. 22 predicted price growth of 0.3 per cent this year and 1.1 per cent in 2016. The bond-buying program is seen boosting inflation by 0.4 percentage point and 0.3 percentage point, respectively, according to a euro-area central bank official who has seen the ECB’s internal calculations.

Core inflation slowed to 0.5 per cent in January from 0.7 per cent in December, data show. That's the lowest since the euro was introduced in 1999. ECB Executive Board member Benoit Coeure said in a Bloomberg Television interview last week that QE could be expanded or extended if the impact on prices isn't judged enough. "It will end only once we get a strong sense that inflation is converging toward 2 percent," he said in an interview with Italian newspaper Corriere della Sera published on Thursday. At the same time, "all of the lights are green" for the economy, he said. "2015 could see significant growth."

In a sign that growth momentum is picking up, euro-area economic sentiment rose in January for the first time in three months to its highest since July. Manufacturing and services activity expanded at the fastest rate in five months at the beginning of 2015. Unemployment fell to the lowest level since August 2012, Eurostat said in a separate report.

The rate stood at 4.8 per cent in Germany, and at 23.7 per cent in Spain. In Greece, persistently high joblessness has contributed to a backlash against austerity and was one of the key factors behind the victory of the Syriza party in elections. Prime Minister Alexis Tsipras’s pledge to renegotiate bailout terms and write down debt has alarmed investors already concerned about the future of the currency bloc and its economy.

“The new Greek government is starting with very strong messages,” said Gilles Moec, chief European economist at Bank of America Merrill Lynch said in an interview with Guy Johnson on Bloomberg Television’s The Pulse. “Thank god they actually moved with QE before we got the results of the Greek elections.”

Bloomberg