In a development that has fueled talk of an interest rate cut, eurozone inflation falls again

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LONDON – The pressure on the European Central Bank to cut interest rates again ratcheted up on Friday after figures showed inflation unexpectedly falling further below its target.

Consumer price inflation in the 18-country eurozone fell to 0.7 per cent in the year to January from 0.8 per cent the previous month, the Eurostat agency said.

The decline was unexpected — the consensus for a rise to 0.9 per cent — and reinforced fears that the eurozone is about to suffer a Japanese-style bout of deflation that would further hobble the stagnant recovery. Once prices start to fall, economies can become moribund as consumers delay purchases in the hope of getting bargains later and businesses postpone investment and innovations.

The ECB holds its monthly meeting Thursday and a growing number of economists think it may ease monetary policy soon in response to these deflation fears. The ECB targets inflation at just below 2 per cent. The U.S. Federal Reserve, by contrast, also monitors unemployment.

CUTTING RATES TO STIMULATE?

Some economists think the central bank’s Governing Council will reduce its main interest rate to 0.10 per cent from the current record low of 0.25 per cent. Cutting rates can help lift inflation by stimulating demand and by reducing the euro, which would make imports more expensive.

“The Governing Council needs more bad news on inflation like a hole in the head,” said Richard Barwell, economist at Royal Bank of Scotland, one of a handful who predicted last November’s interest rate reduction.

“On balance we think that a rate cut is the brave thing to do and the right thing to do and that is what we expect the Council to do,” he added.

WHY IS THERE ANY DOUBT THE ECB WON’T CUT THEN?

Other analysts reckon the ECB will hold off for a month at least, mainly because other economic indicators have been more upbeat of late.

Though the eurozone economy grew by a quarterly rate of only 0.1 per cent in the third quarter of 2013, recent surveys on confidence among businesses and consumers have suggested that growth may be picking up even in those countries that have been bailed out, such as Portugal and Spain. Also, the drop in inflation was largely due to falling energy costs, which may, for example, free up money for cash-strapped households.

DON’T UNEMPLOYMENT FIGURES SHOW THE WORST IS OVER?

A separate release by Eurostat showed unemployment in the eurozone fell by 129,000 in December to 19.01 million. The decline was the biggest fall since April 2007 and largely due to an 81,000 drop in Spain, which many economists think is on the mend following wide-ranging labour market reforms.

The overall unemployment rate in the eurozone, however, was unchanged at 12 per cent and not far off its all-time high of 12.1 per cent.

Though many economists think that unemployment may have peaked, any further drops are expected to be modest and inconsistent. The turmoil that has engulfed emerging economies and shaken world financial markets shows how fragile the global recovery is.

WOULD A RATE CUT HELP THE ENTIRE EUROZONE?

Economic conditions vary greatly across the region, making it difficult to set interest rates at an appropriate level for different economies. While countries like Germany and Austria have unemployment rates around 5 per cent, Greece and Spain still need support as they have more than one in four people out of work.

The situation among the young is even starker, with the youth unemployment rate in Greece up at 59.2 per cent in October, the last month for which figures were available. Spain, though, saw its youth unemployment rate fall to 54.3 per cent in December from 55.2 per cent, as the number of under 25 year olds out of work fell by 20,000.

WHAT OTHER TOOLS ARE AVAILABLE?

The ECB has insisted that it can only do so much. Governments have to continue getting their public finances in order and push ahead with reforms to their economies.

But the central bank does have some tools besides rate cuts at its disposal. Its president, Mario Draghi, has said the ECB is considering all its options.

The ECB could, among other things, make the deposit rate negative, a move that would essentially make banks pay to have their money parked at the central bank. That, the theory goes, may make them lend more, which would shore up economic activity and stimulate inflation.

The ECB could also offer banks another round of long-term loans, though recent comments from Draghi suggest that’s not imminent. A U.S.-style monetary stimulus, in which the amount of money in the economy is increased, is considered a long-shot, largely because of Germany’s historic reluctance.

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