Thursday, September 3, 2015

Draghi ECB Day comments sink the Euro | An inflation conundrum

Right from the start of Mr. Draghi’s opening remarks at yesterday’s Monetary Policy Statement and press conference in the ECB headquarters in Frankfurt, the Single Currency started to fall, and this continued for the remainder of the trading session. The ECB has revised down its inflation rate estimates for the coming years, and also its expectations of economic growth. In light of this, it stands ready to do more if the current program of Quantitative Easing, which will run its course, does not result in a lift to inflation.

The ECB has also increased the percentage of any sovereign bond issuance that it can buy under the program, from 25% to 33%. This will not result in more QE, but will ‘smooth’ the process of continuing what has already been embarked upon.

Mr. Draghi said that they expect inflation to go negative in the coming months, due to low oil prices, but that this is expected (hoped?) to be a transitory phenomenon.

An inflation conundrum

One thing that emerged from the question and answer session was an illustration of the way the ECB views inflation, or price stability as it calls it. Firstly, under its mandate from the EU, it is its only concern. The bank has no role to play in job creation or in managing a rise or fall in the value of the currency, unlike other central banks. Most surprising to this writer was the statement by the President that it was headline inflation, rather than core inflation, which informs ECB policy decisions. The surprise here lies in the fact that core inflation has the cost of energy removed from its calculations. And core inflation is rising. In the meantime, lower energy costs feed through into the pockets of consumers and the profits of businesses, and so, one might be tempted to think, should be seen as a good thing. Mr. Draghi did temper his remarks on this subject by saying that the bank was “aware” of the way core inflation was going. We might just hear more about this matter in the future.

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