Eurozone posts negative inflation, but QE still being questioned

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Initial estimates of the Eurozone CPI saw the headline inflation fall -0.2%, below consensus estimates of 0 to -0.1% while core inflation on an annualized basis which excludes volatile components such as fuel managed to rise to 0.8% beating estimates of 0.7%.

While proponents of the ECB’s QE program view the headline CPI reading as a trigger for the Central Bank to announce its QE purchase program as early as its January 22nd meeting, there has been a growing concern from other circles that the conditions are still not ripe to call for the drastic measures.

The main reason of the debate comes from the opponents of QE who seem to regard deflation as a period where consumer spending is held back as consumers expect prices to fall further, this in effect translates to lower employment and production which could result in weaker economic growth.

In this aspect, besides the CPI reading, other factors such as consumer spending should be taken into account. The most vocal opponent to the QE and one that backs this view come from German Bundesbank chief Jens Weidmann. But obvious from the above, the main risk to such view comes from the fact that ECB would have to wait until the GDP numbers confirm deflation and then act, something which could take a lot more efforts than taking a preemptive step.

However, the ECB’s chief economist Peter Praet, in an interview with a German newspaper late in December noted that if the ECB continues to ‘wait and watch’ in hopes of weathering out the current slump could well miss the boat and could result in a longer term anchoring of deflation, which would take a much larger efforts by the ECB to climb back from the pit of deflation.

ECB’s QE Options

It is being rumored as per reports from various news media outlets that the ECB is considering three options for its QE program.

The first option includes an outright purchase of AAA rated bonds, which could push the yields to negative territory, meaning that investors have to pay in order to hold on to the high rated bonds. This is being seen as an effort to push investors to purchase lower rated bonds in the Eurozone.

A second option considers involving the regional Central banks to purchase their sovereign debt which could in effect keep the risks contained to the Eurozone countries and could prevent any contagion.

The third and final option being floated is for the ECB itself to purchase sovereign bonds based on the risk impact for each of the Eurozone member countries.

Needless to say, Germany will most likely oppose options 2 and 3 as it considers these options to be counterproductive to its austerity measures and could also encourage countries to put off fiscal reforms in a lower risk environment.

No matter what, and regardless of the dissent posed by Germany, it is starting to get increasingly clear that the ECB could likely embark on its QE purchases. While countries such as Spain posted negative inflation and with Germany and Italy almost on the brink of dipping into negative inflation numbers, it will be interesting to see if the ECB will move first and announce the QE measures or if the central bank will perhaps wait for a month or two before it is convinced that QE is needed.

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