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September Euro Area Annual Inflation Misses Expectations

Posted: Friday, October 2nd, 2020

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The highly anticipated September Euro area annual inflation declined further. It reached -0.3% in September from -0.2% in August, and the trend looks poised to continue.

Moreover, the core Euro area annual inflation declined too, reaching 0.2%, coming down from 0.4% a month earlier. For the European Central Bank (ECB), this is bad news.

Because the ECB targets inflation below but close to 2%, it must react to the threat of inflation falling below zero. Traders know that the ECB’s favorite way of measuring inflation is the core data, and September’s decline opens the gates to more stimulus.

Euro Area Annual Inflation

What Can the ECB Do?

The ECB already lowered the deposit facility rate below zero several years ago. Therefore, with the interest rates basically at the lower boundary, it must look at other ways to stimulate the Eurozone economies.

It did so by activating the Quantitative Easing program. Also, it reacted well to the stringent needs created by the pandemic.

But now that the Euro area annual inflation keeps falling, the only game in town remains an expansion of the QE program.

Staff Projections Missed the Decline in the Euro Area Annual Inflation

Curiously enough, the ECB kept a hawkish tone at the previous meeting. When asked about the core inflation at 0.4% at that time, Christine Lagarde, the ECB’s President, said that it comes in line with the bank’s expectations.

However, inflation watchers in the Euro area had a different opinion. All data pointed to further declines, and a move lower in the core inflation was the next logical step.

Yet, the staff projections did not reflect it. Hence, the Euro did not correct from its highs in the aftermath of the ECB’s last meeting.

QE Expansion – October or December?

Today’s data comes as a confirmation that inflation threatens to drop below zero. At that point, deflation threatens economic growth, and it may be too late for the ECB to react. For a central bank, the credibility that it can reach its mandate matters the most—also, the ability to do so.

Therefore, starting with today, the expectations grow that the ECB will further ease the monetary policy stance. The next meeting on the 29th of October is just a few days away from the U.S. election data and the Federal Reserve’s decision. Hence, the ECB may wait to see the outcome on the other side of the Atlantic before moving in December.

However, the risk is that the Euro area annual inflation keeps falling. And, the further it falls, the more difficult is for the ECB to fight it.

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