Eurozone deflation will persist in coming months, Lagarde warns

Eurozone deflation will persist in coming months, Lagarde warns

The eurozone is expected to remain in deflation over the coming months, partly because of the recent appreciation of the euro, European Central Bank president Christine Lagarde has warned.

Headline annual inflation is “expected to remain negative over the coming months” after slipping into deflation in August for the first time in four years, Ms Lagarde told the European Parliament’s committee on economic and monetary affairs on Monday.

She cited “earlier declines in energy prices, a stronger euro, and a temporary reduction in the value added tax rate in Germany” as the main drivers for the sustained fall in prices.

Price growth has slowed or stalled in most of the single currency bloc’s economies since the pandemic first hit this year, as weaker demand put many jobs at risk, consumers became cautious and the uncertainty of the outlook weighed on business spending.

Eurozone prices contracted 0.2 per cent on an annual basis in August as the stronger euro made imports cheaper. It also increased the cost of the bloc’s exports, another factor weighing on the economic recovery.

The ECB’s governing council “will carefully assess all incoming information, including developments in the exchange rate, with regard to its implications for the medium-term inflation outlook” and “continues to stand ready to adjust all of its instruments, as appropriate, to ensure that inflation moves towards its aim in a sustained manner”, Ms Lagarde said.

ECB forecasts expect the period of deflation to be limited, with the inflation rate averaging 1 per cent over the course of next year. But eurozone inflation is not expected to rise above 1.3 per cent in the next three years, according to the ECB’s forecasts — well under its target of below, but close to, 2 per cent.

Ms Lagarde said that the bank was not complacent about inflation being well below its target, but that without the monetary policy measures the ECB had taken since the start of the pandemic, “we would be facing a deeper economic contraction and more severe disinflation”.

The ECB’s measures include offering cheap loans to banks in a bid to stimulate lending to households and businesses, and a €1.35tn bond-buying programme.

Marchel Alexandrovich, European economist at Jefferies, said that Ms Lagarde “relies heavily on the inflation outlook to justify the ECB’s accommodative policy stance”.

“Below-target inflation is something that helps to cut through whatever opposition there may be to the ECB’s extraordinary policies: whether that opposition comes from members of the EU Parliament or from some on the governing council itself,” he added.

Ms Lagarde warned the European Parliament committee that output in the eurozone was not expected to recover to pre-crisis levels until late 2022, and “the public health crisis will continue to weigh on economic activity and poses downside risks to the economic outlook”.

The eurozone economy rebounded in the third quarter, but the recovery “remains incomplete, uncertain and uneven”, she said.

The recovery is limited by consumers who “remain cautious owing to anxiety about their job and income prospects”. Business investment is also subdued despite the pick-up in the third quarter as “elevated uncertainty continues to weigh on firms’ investment plans”.

National measures such as job retention schemes and guarantees for companies’ bank loans “remain critically important factors . . . in softening the impact of the pandemic”, Ms Lagarde said.

She also announced a fresh push for transparency in the ECB’s governance. From now on the central bank will publish the opinions of its ethics committee in cases of conflict of interest involving members of the ECB’s executive board, governing council and supervisory board.