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Eurozone Inflation at Five 1/2 Year Low, ECB Ponders Policy

Posted by Joseph Trevisani on Jun 3, 2014 11:37:00 AM

Annual inflation in the European Monetary Union dropped unexpectedly to the lowest level since late 2009 increasing the pressure on the central bank and President Mario Draghi to act to forestall deflation.

The consumer price index for the year fell to 0.5 percent in May from 0.7 percent in April, equaling March's 0.5 percent and the lowest 12 month inflation since -0.1 percent in October 2009.   Analysts had forecast a smaller decline to 0.6 percent.  The ECB has a target rate of just below than 2.0 percent. EMU inflation has not been at 2.0 percent since January 2013.

The ECB had said for much of the year that it expected inflation to accelerate in the second quarter and April’s rise to 0.7 percent from 0.5 percent in March was taken as evidence that the bank's expectation might prove correct.

May's drop again to the post-recession low puts the spotlight on the central bank policy meeting this Thursday. There is widespread expectation that the bank will cuts it main refinance rate from 0.25 percent to 0.1 percent and take the deposit rate negative for the first time in history by instituting a charge to commercial institutions for keeping funds at the ECB.

European bond yields have fallen dramatically this year as investors anticipate the decision of the central bank.  At the last ECB meeting in May President Draghi promised that the ban would act in June to prevent deflation and provide more economic support for the EMU's struggling economies.

German government bond yields are close to levels not seen in almost 200 years.

Rates on the generic German 10-year bond were 1.40 percent in London afternoon trading not far from the 1.17 percent low reached at the height of the European debt crisis in May 2012. That interest rate had been the lowest since 1815 and the Napoleonic Wars. Over the past ten years the interest rate on this security has average 3.00 percent, over the past thirty years the average is 4.85 percent.

The Spanish generic 10-year bond was paying 2.85 percent, the Italian 2.99 percent and the French generic 10-year bond was returning 1.81 percent. All at or very close to multi-decade lows.

Yields on bonds from Belgium, Austria and France had declined to all-time lows last month.

First quarter GDP in the monetary union was just 0.2 percent on the quarter, half the 0.4 percent forecast. Of the four largest economies Germany grew 0.8 percent, France was flat, Italy shrank 0.1 percent and Spain added 0.4 percent.

The ECB is forbidden by charter from the type of direct intervention in the credit markets characterized by the U.S. Federal Reserve’s quantitative easing programs.  Such intervention is also opposed by Germany the monetary union’s largest member and strongest economy

Joseph Trevisani

Chief Market Strategist

WorldWideMarkets Online Trading

Charts: Bloomberg

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