Inflation Turns Negative In Euro Area, Raising The Chances Of Quantitative Easing

fallingConsumer prices in the 19 member states of the euro area dropped more than was expected and moved into negative territory  for the first time since October 2009 during the height of the financial crisis, raising the chances that the European Central Bank (ECB) will move closer towards adding another layer of monetary stimulus through a € 1 trillion U.S. style quantitative easing program that consists of purchasing  government bonds or sovereign debt from the 19 countries making up the euro area.

Eurostat reported this morning that annual inflation in the 19 member currency area declined -0.2 percent year over year and was noticeably below November’s positive reading of 0.3 percent.

The consensus December estimate was for a gain of 0.1 percent.

Eurostat acknowledged that the decline in consumer prices was largely driven by declining energy prices that was especially felt in December (- 6.3 percent compared with -2.6 percent in November).

Falling inflation levels are a concern to euro area businesses that may delay their investment spending as anticipated cash returns decline due to falling prices.

The European Central Bank will be faced with increased pressure to act more aggressively to lower deflationary concerns as an oversupply of global oil combined with weaker global growth has driven the costs of oil much lower in recent weeks.

The European Central Bank (ECB) has an upcoming policy meeting on January 22nd.

One potential reason that the ECB may delay launching a € 1 trillion U.S. style quantitative easing program centers around Greece’s election held a few days later on January 25th with many lingering questions about the style of government that will be forming in Athens due to the sudden rise of Syriza Party, a leftist party that has called for a write down of Greek debt and a reduction in austerity.

Reuters reported yesterday that the European Central Bank is considering three approaches towards purchasing government bonds if the central bank decides to add more monetary stimulus during their upcoming January 22nd monetary policy meeting.

Reuters obtained this information from Dutch newspaper Het Financieele Dagblad that cited an unnamed source and resembles comments made last week by ECB Economist Peter Praet to a German newspaper.

The unnamed source said that the ECB is considering to add liquidity into the financial system by having the ECB itself buy government bonds in proportion to the given member state’s shareholding in the central bank.

A second option is that the ECB would only buy triple A rated government bonds, driving their yields down to zero or negative territory and emboldening investors to buy riskier sovereign and corporate debt.

The third option is similar to the first, but the national central banks would do the buying and the risk would remain with the country in question that is holding the paper.

-Johnathan Schweitzer

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