Complacent ECB warned of deflationary disaster

Commentators have backed credit while warning of the “spectre of deflation” in the eurozone after the ECB surprised analysts with an interest rate cut to 0.25%.

Complacent ECB warned of deflationary disaster


ECB president Mario Draghi based the decision on low inflationary forecasts and further economic weakness, and this has been greeted by most as a necessary move with the Bank having been accused of being slow to react in the past.

However, Stewart Robertson, senior economist at Aviva Investors, believes that Draghi and co have been complacent about CPI inflation numbers as he warned of deflationary risk.

“We are more concerned and see worrying similarities with the situation in Japan 20 years ago, when the extended deflationary period began from which it is only now emerging,” he noted.

“In our view there is a very real risk of deflationary forces taking root in many countries within the eurozone and indeed the area overall. If weakness persists, as we believe, then the ECB will come under pressure to do even more in the future. We hope that they do, including some of the bolder, unconventional monetary policy measures (QE) that have been employed elsewhere.”

Luke Bartholomew, investment analyst at Aberdeen Asset Management, said with inflation falling and the euro appreciating significantly recently, it makes economic sense for the ECB to cut rates. However, he too is worried about inflation.

He added: “Draghi knows that the spectre of deflation is stalking the eurozone and wants to be seen to be taking action. The rate cut is a strong signal that the ECB will do everything it can to fight deflation and take the action that economic recovery requires.”

For Chris Iggo, CIO Fixed Income at AXA IM, the rate cut is a strong signal that the ECB is willing to ease policy further, and he pointed to a marked reaction with bond yields in core and periphery markets lower, equities up and the euro falling in value relative to other major currencies.

“This is good news for fixed income assets as the ECB is still clearly in easing mode and therefore will be committed to a lower for longer interest rate policy,” he said. 

“The ECB also said that it expects rates to remain at current or lower levels for an extended period of time, based on the view that the central bank expects inflation to remain low for some time, implying that rates could be reduced again.

“This should mean lower yields across the core and peripheral curves and some flattening of yield curves. It is good news for credit as it locks in lower financing costs for euro borrowers when credit fundamentals are already favourable.”

Elsewhere, Guy Foster, head of portfolio strategy at Brewin Dolphin, believes the ECB will need to go further with its intent in its December meeting.

“Most forecasters didn’t see this cut coming because it hadn’t been previously signalled by the ECB,” he said.

“What this decision, and the September tapering debacle show, is that while central bankers want to be transparent about their thinking, this only really helps when know what to think.”



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