Eurozone inflation downgrade backs ECB's ultra-slow exit

An unexpected downward revision to eurozone inflation and a softening in labour costs came just hours after ECB chief economist Peter Praet opposed any early tweaking of the institution’s language on stimulus. He said policy makers have been surprised by an influx of new workers that could be suppressing wage and price pressures.

Investors are on guard for any decision by the ECB to end its bond-buying programme and start the clock ticking on an interest-rate increase that could come around the middle of 2019. That would be the first tightening measure in President Mario Draghi’s eight-year presidency, which ends in October 2019 and has so far been dominated by crisis measures aimed at averting deflation and the breakup of the bloc.

“The message is that it’s going to be a very slow exit process,” said Nick Kounis, an economist at ABN Amro in Amsterdam. “Bringing net asset purchases to an end will be quite protracted and also rate hikes will be quite a long way off. It’s all going to be very slow because the recovery in inflation will be very slow.”

While the eurozone is now undergoing its most-robust economic expansion in its near two-decade history, wages and prices are failing to follow suit. Friday’s inflation reading showed the rate at 1.1% in February, down from an earlier estimate of 1.2%. That’s the lowest since late 2016, and well below the ECB’s goal of just under 2%.

The core rate, excluding volatile components such as food and energy, held at 1%.

Back to work

Separate figures showed labor costs, which include wages as well indirect benefits such as social insurance, slowed to 1.5% last quarter, the weakest since the start of 2017.

The euro weakened briefly on the data. It was up 0.1% at $1.2322 at 13:24.

What Bloomberg economists say:

“This lack of progress is likely to mean the ECB winds down its asset purchase programme slowly. We don’t expect another significant step from policy makers in Frankfurt until June.”David Powell and Jamie Murray, Bloomberg Economics.

Draghi noted earlier this week that the degree of slack in the economy is uncertain, saying that policy makers therefore have to be more cautious in communicating the path of stimulus.

“I would not revise the guidance too early, because that could send wrong signals about the end of our net asset purchases,” Praet said in an interview with Reuters. “We are all surprised by the reaction of the labour market to better economic conditions. The increasing participation of women and older people is certainly making an impact.”

Faster Fed

Even so, he acknowledged that investors don’t expect the bond-buying programme to run much longer, and said the ECB will eventually need to address that by changing its language on interest rates.

The ECB started slowing its bond-buying programme in April 2017, when it reduced monthly purchases to €60bn from €80bn. The pace dropped to €30bn at the start of this year, and buying is scheduled to run until at least September. The central bank will reinvest the proceeds of maturing debt, and expects to keep interest rates at record lows until “well past” the end of net purchases.

That progress contrasts with the US Federal Reserve’s exit from its own emergency measures. It reduced buying from $85bn in $10bn steps over 10 months to October 2014, with the first rate increase coming in December 2015. The Fed is widely expected to raise rates again next week, the sixth increase since the end of quantitative easing.

“The ECB seems to be pacing a more patient exit than the Fed did,” Paul Mortimer-Lee, chief markets economist at BNP Paribas, said in a note. “The ECB seems to be guided more by actual inflation, whereas the Fed seems driven more by growth and unemployment.”

Kounis said policy makers may be sending mixed signals on what it’ll take to pull the plug on purchases though. While Praet and Draghi have said they’re more confident that inflation will eventually return to target, they’re also trying to play up the amount of slack.

“They need to be a bit more careful with their messaging here,” Kounis said. “There is certainly some confusion about what they really need to see.”