Euro zone inflation slows as pressure on ECB to act mounts

Euro-area inflation slowed more than economists forecast in May, cranking up pressure on the European Central Bank to deploy a range of measures to kindle prices and drive growth.

The rate fell to 0.5 per cent from 0.7 per cent in April, the European Union’s statistics office in Luxembourg said today. The rate has been less than half the

ECB’s target for eight months.

With ECB president Mario Draghi warning about the risk of a negative price spiral, the governing council is considering measures from negative interest rates to conditional liquidity for banks.

The central bank is also contending with high unemployment, which unexpectedly decreased in April while remaining near a record, a separate Eurostat report showed. “The fact that inflation is so low and so far below target is clearly contributing to the general pressure on the ECB to do more,” said Jonathan Loynes, chief European economist at Capital Economics Ltd in London.

“Draghi, not surprisingly, has played down the threat of deflation, but as inflation has fallen further it’s pretty clear it’s having an influence on their thinking.”

The euro erased losses against the dollar after today’s date were released, trading at $1.3607 earlier in Brussels, up less than 0.1 per cent on the day.

Of 50 economists surveyed by Bloomberg News, 44 expect the Frankfurt-based ECB to become the first major central bank to take interest rates into negative territory by cutting its deposit rate. All but 2 of 60 respondents said the benchmark rate would also be reduced.

The ECB has prepared investors for the prospect of stimulus when it announces the rate decisions on June 5th. “We are ready to act,” ECB vice president Vitor Constancio said on May 30th. “We are not complacent about the risks from a protracted period of low inflation.”

A possible interest rate cut by 0.1 to 0.15 percentage point would have little impact, as the rate tool has been exhausted, former ECB chief economist Juergen Stark wrote in today’s Frankfurter Allgemeine Zeitung.

Energy prices stagnated in May, after declining 1.2 per cent the previous month, today’s data showed. Prices of alcohol, food and tobacco rose 0.1 per cent following a 0.7 per cent gain in April. The cost of services increased 1.1 per cent.

The core inflation rate, which excludes volatile items such as energy, food, tobacco and alcohol, was 0.7 per cent after a 1 percent reading in April, according to Eurostat.

Today’s data are estimates. The statistics office will release final figures for May on June 16th. Anemic growth in the euro zone has added to the case for ECB stimulus, as policy makers continue to struggle with the legacy of the debt crisis.

Unemployment in particular has proven resistant to their interventions. The jobless rate fell to 11.7 per cent in April from 11.8 per cent a month earlier, according to Eurostat.

Across the currency bloc’s 18 countries, rates ranged from 4.9 per cent in Austria to 25.1 percent in Spain. Among people under the age of 25, the unemployment rate was 23.5 per cent. “Unemployment continues to decline in the EU’s 28 member states as a whole as well as in the euro area, which is encouraging,” the bloc’s employment commissioner, Laszlo Andor, said in a statement.

“However, many new jobs are precarious, and we are far from ensuring that every person has a real opportunity in the labor market.”

Even Europe’s lowest government bond yields since the Napoleonic Wars are signaling investors want more action from Mr Draghi.

Instead of a vote of confidence, the most pronounced rally in 200 years suggests the ECB needs to stave off the risks of stagnation and deflation. Aside from the prospect of a negative rate, the ECB is working on a proposal for a conditional longer-term refinancing operation and expects to have a plan ready for the June 5th meeting, according to a central bank official familiar with the plans.

Details on cost, maturity and the appropriate measure of credit supply have yet to be finalised, the official said, asking not to be identified because the talks are private. In addition to providing detail on any new ECB stimulus, Mr Draghi will unveil the new macroeconomic projections.

The central bank forecast in March that inflation would average 1 percent this year and 1.3 per cent in 2015.

Bloomberg