Sub zero: eurozone inflation sinks well below expectations

So, there’s a European Central Bank meeting coming up, you say? Here’s some fodder for the governing council’s deliberations: the first reading of eurozone inflation for February has produced a reading of -0.2 per cent, back below zero after four months of positive readings.

The ECB targets just under 2 per cent annual inflation. Economists had expected to see an unchanged reading from the previous month’s +0.3 per cent.

No prizes for guessing what’s dragging it down, but this chart from Eurostat may help:

It appears that the drag from energy is biting with renewed force. Optimists had predicted that oil prices would stop sliding, scrubbing out the impact on inflation readings. Instead, the black stuff is still sliding, which means that prices fell by 8 per cent on the year in this first estimate for February, from a drag of 5.4 per cent in January and 5.8 per cent in December. Stripping out energy, the annual reading is +0.7 per cent.

Your move, ECB.

From Pictet:

Says Pictet’s Frederik Ducrozet:

The real bad news came from non-energy prices as core HICP inflation (excluding energy, food, alcohol and tobacco) unexpectedly dropped by 30bp, to 0.74% y-o-y in February, its lowest level since April 2015.

Today’s inflation report is likely to deliver the final blow to the ECB. We continue to expect a comprehensive easing package at the 10 March meeting, including a 10bp deposit rate cut (along with a tiered deposit system), a €20bn increase in the pace of asset purchases (along with changes to QE modalities) as well as new TLTROs (with looser terms and conditions).

A more significant easing package is becoming increasingly likely after today’s data. Despite aggressive market expectations, a positive surprise cannot be ruled out.

Capital Economics writes:

February’s drop in euro-zone CPI inflation back into negative territory intensifies the pressure on the ECB to announce a decisive increase in its policy support after it meets next week. The fall in the headline harmonised rate, from +0.3% to -0.2%, was below the published consensus forecast of zero, although expectations may have weakened since the release of German, French and Spanish data late last week.

This is the first time that euro-zone inflation has been below zero since last September. The decline was partly down to an expected fall in energy inflation on the advent of a sharp rise in oil prices in February 2015. Food inflation weakened too. But most worryingly, the core rate (excluding food and energy) fell from 1.0% to a 10-month low of 0.7%.

…This, together with low and falling inflation expectations, should give the doves on the Governing Council plenty of ammunition. We still see the Bank announcing another cut to the deposit rate, perhaps of 20bps, and an increase in the pace of monthly asset purchases from €60bn to €80bn or so.

RBC says the stumble below zero is “unlikely to be a major source of surprise” to the ECB, but it will still perk up the doves on the rate-setting committee.

A ‘wait-and-see’ approach simply does not appear to be a viable policy option at this stage.

As on previous occasions, much of the slump this time around can be traced back to the energy component, where the drag this month was far more pronounced than it was in January (-8.0% y/y from -5.4%). However, this is far from the full story; price pressures in services and non-energy industrial goods also eased noticeably this month, and it is their inclusion in the ‘core’ measure that helps explain its sharp drop to 0.7% y/y February. It is this decline in core inflation that is likely to raise more eyebrows within the Governing Council, as some have leaned on its relative stability as a source of comfort amidst the persistent gyrations in the headline rate.

Says Aberdeen Asset Management investment manager Patrick O’Donnell:

A lurch back into deflation is the last thing the eurozone needs. The main cause was energy price falls and a fall in unprocessed food price inflation. Most worrying is the fall in the core inflation measure which fell 0.3% to 0.7% year on year in February. This was led by falls in non-energy industrial goods and services. The latter may have be driven by the amount of package holidays sold which volatile but the Governing Council at the ECB is going to be worried by all of this. Some of them have been holding out for more data to make a decision about whether the central bank will need to do more to stimulate the region’s economies.

This data, coupled with the recent weaker survey data will probably force the ECB’s hand and makes it more likely we’ll see further negative rates and more quantitative easing from the ECB in March. Sadly, the continent’s policy makers continue to simply look to the magical Mario Draghi and the ECB to conjure up a solution.