European Central Bank boss hints at stimulus to fight deflation

The president of the European Central Bank has raised expectations that he will turn on the money-printing presses to fight deflation early in the new year, sending the euro to its lowest level against the dollar in four and a half years.

In an interview with the German financial daily Handelsblatt, Mario Draghi said the risk of inflation failing to return to its targeted level of 2% had grown in the past six months, alerting markets that the central bank could announce further stimulus as soon as its next meeting on 22 January.

The euro fell to $1.20, its lowest since June 2010 when the currency was reeling, having agreed Greece’s first €110bn bailout the previous month.

Eurozone inflation has already slipped to 0.3%, far off the ECB’s price-stability target of just below 2%, and economists polled by Reuters expect the single currency zone to have sunk into outright deflation in December. They forecast falls of 0.1% when figures are released next Wednesday, with prices driven by plunging oil prices.

Spain and Greece are experiencing falling prices and some economists are warning that the 19-strong currency bloc could become mired in a deflationary spiral that further dampens spending and consumer confidence.

Oil prices fell to a five-year low on Friday, with benchmark Brent crude tumbling to $55.67 by lunchtime trading in London.

Although Draghi said the risk of deflation in the eurozone was limited, he indicated the ECB was becoming more concerned. “The risk that we do not fulfil our mandate of price stability is higher than six months ago,” he said. “We are in technical preparations to adjust the size, speed and compositions of our measures in early 2015, should it become necessary to react to a too-long period of low inflation. There is unanimity with the governing council on this.”

He said government bond purchases were among the tools the ECB could use to fulfil its price-stability mandate.

Buying government bonds, a policy known as quantitative easing, is seen as one of the last weapons in the ECB’s arsenal to revive the eurozone, with interest rates having already been knocked down to 0.05%.

Holger Schmieding, chief economist at Berenberg bank, said Draghi’s words signalled that the ECB was likely to announce sovereign bond purchases on 22 January. “It is not about the actual size of the bond purchases; the key is whether they send a strong and credible signal to investors.”

But he also challenged the view of some economists that lower prices were bad for the eurozone. “Deflation is not much of a problem. We are grateful that oil prices are lower and that is a good thing for the real economy. The weak state of demand is the problem and the ECB ought do be doing something to stimulate confidence.”

Draghi’s remarks came as data showed that Europe’s manufacturing output was stagnant at the end of 2014. Eurozone factory output was on course for its worst performance since the recovery began in autumn 2013, according to the Markit survey of purchasing managers. The headline index rose to 50.6 in December, slightly up from November’s low of 50.1, but still a lacklustre performance on an index where anything over 50 counts as expansion.

Ireland, Spain and the Netherlands performed better than average, but factory output in France, Italy, Greece and Austria fell as orders continued to decline. Germany saw a modest growth in factory output, but some economists remain worried about subdued growth in the eurozone’s largest economy.

“The ongoing weakness of German manufacturing also remains a major source of concern, but there are signs that order book growth could be turning around, with inflows of new work edging higher for the first time in four months,” said Chris Williamson, chief economist at the survey compiler Markit.

In the Handelsblatt interview, Draghi insisted there was no question of weaker countries being forced out of the eurozone. “A breakup of the eurozone? That will not happen. That’s why there is no plan B,” he said. He also called on states to step up reform plans, by reducing tax and red tape.

But a senior ally of Angela Merkel warned the ECB against embarking on financial stimulus without economic reforms from the weaker countries of the eurozone.

Michael Fuchs, deputy parliamentary floor leader of the German chancellor’s Christian Democrats, said: “We shouldn’t pump extra money into these states, but rather make sure they continue along the reform path.”

In remarks reported by Reuters, he said there would be “fierce discussion” about the ECB’s bond-buying plan at its next policy meeting, referring to well-known opposition to quantitative easing from the head of the Bundesbank, Jens Weidmann.