ECB Raises Eurozone Deflation Concerns

As inflation rates in the Eurozone fall to zero, the European Central Bank is bracing for deflation in early 2016.

ECB President Mario Draghi said in an interview Saturday that the ECB is bracing for the European Union’s low inflation rate to turn negative. “We expect inflation to remain close to zero, and maybe even to turn negative, at least until the start of 2016,” Draghi said.

As inflation rates in the Eurozone fall to zero, the European Central Bank is bracing for deflation in early 2016.

ECB President Mario Draghi said in an interview Saturday that the ECB is bracing for the European Union’s low inflation rate to turn negative. “We expect inflation to remain close to zero, and maybe even to turn negative, at least until the start of 2016,” Draghi said.

While deflation expectations are just short term, Draghi pointed the finger at an inefficient labor market in the European Union as a cause for negative income growth, insisting that the labor market needs reforms to benefit businesses if employment will improve. “The crisis led to a sharp drop in incomes. It is up to us to push them up again,” he said, adding that policy reforms, not monetary stimulus, are the key. “This requires the necessary structural reforms to be carried out in order to increase labour force participation rates and boost productivity.”

Draghi is eager to see more flexibility in the labor market, which means it will be easier for companies to fire employees without just cause, and for mandatory benefits to decrease in order to make hiring more affordable for employers. “There are still at least 20 million unemployed people in the euro area – many of whom are young – who need to be brought back into the labour market. This represents enormous potential,” he said.

Still, the ECB is contemplating other options to improve economic conditions in the European Union, with Draghi referencing a “menu” of options beyond the 1.1 trillion euro bond-buying program currently in place. On that program, Draghi expressed no regrets.

“Overall, I would not say that we acted late: we took note of the information, which became available and at the same time drew up the conceptual framework that led to these decisions,” he said.

Devaluing Currency

While short-term deflation is likely, Draghi believes a “mechanical” return to inflation is likely in early 2016, due to the low cost of oil in early 2015. “The effect of the sharp decline in oil prices that we have seen between the end of 2014 and the end of this year will disappear from the one-year ahead annual price index,” he noted. While this is a return to price growth, Draghi did not suggest this will lead to a stable or improving economy in the Eurozone, and that it may not boost aggregate demand.

At the same time, Draghi said a depreciation of the euro is likely to cause an aggregate increase in prices in the Eurozone, and achieving greater money velocity because of the negative bank deposit rates that the ECB successfully implemented in 2014. Draghi also noted some non-euro European countries have introduced even lower negative interest rates, and that the market reacted “in a completely calm and smooth way to the new interest rate.”

He also hinted that the minimum interest rate, currently set at -0.20%, is a “technical constraint” that can change if conditions permit. That hints at the possibility of even lower negative rates in the euro, and the possibility that banks in Europe will begin charging depositors for holding their money.