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Weak inflation could prompt ECB rate cut: Analysts

Frankfurt: Weaker-than-expected eurozone inflation data could prompt the European Central Bank to cut its interest rates this week, but experts are reluctant to place their bets just yet.

The ECB’s policy-setting governing council is scheduled to hold its regular monthly policy meeting on Thursday.

According to data compiled by the EU’s statistics agency Eurostat last week, eurozone inflation slowed to 0.7 per cent in January from 0.8 per cent in December, turning up the heat on the ECB to prevent the bloc slipping into deflation.

The inflation figure is indeed far below the ECB’s target of just below 2.0 per cent.

According to the central bank’s own latest projections, area-wide inflation will average 1.1 per cent for the whole of 2014.

But ECB watchers believe that that forecast could now be over-optimistic.

“After the softer inflation data in January, the staff forecast of 1.1 per cent on average in 2014 looks too high,” Deutsche Bank chief economists Mark Wall and Gilles Moec wrote in an investors’ note.

They conceded that the lower-than-expected January inflation figure could be due to changes in the way the data are calculated.

But inflation in Germany also come in lower than forecast. And that “raises concern about disinflation spreading to core countries”, the experts said.

At last month’s meeting, ECB president Mario Draghi had taken care not to rule out any further additional monetary easing.

“On balance we believe the ECB will respond to the further disappointing inflation news with a policy rate cut on February 6,” Wall and Moec said.

The ECB took markets by surprise in November and pared back its central “refi” refinancing rate by a quarter of a percentage point to a record low of 0.25 per cent.

The reason behind the move was an expectation that the 18 countries that share the euro are facing a prolonged period of very low inflation.

At the January meeting, Drahi said: “We remain determined to maintain the high degree of monetary accommodation and to take further decisive action if required.”

Capital Economics economist Jonathan Loynes also believed another rate cut could be on the cards.

The ECB’s decision-making governing council “will need to follow up Draghi’s dovish words with further policy action very soon. Another small cut in interest rates, perhaps accompanied by a negative deposit rate, seems the most likely course of action, if not at February’s meeting then soon after,” Loynes said.

The ECB’s so-called deposit rate currently stands at zero per cent and there has been much debate whether the central bank would bring it down into negative territory, an unprecedented move that could have unforeseen repercussions.

UniCredit analysts were not convinced that a move could come as soon as this week, however.

“Markets have started speculating on the possibility of a dovish move in the short term. We think the ECB will reiterate its commitment to maintaining an accommodative stance, but without this leading to immediate action,” the experts said.

Draghi and other ECB officials have insisted time and again that the eurozone is not facing dangerous deflation — a vicious circle of falling prices.

But Wall and Moec at Deutsche Bank warned that in the present environment, “current inflation takes on added significance and all the more so when inflation is very low and the recovery weak, uneven and fragile,” they argued.

“In our opinion, the set of data to emerge over the last month justifies a further easing of the policy stance on February 6. It is a question of timing. If not February, the easing will be in March, accompanying downwardly revised ECB staff inflation forecasts,” the Deutsche Bank analysts said.

In addition to changing interest rates, the ECB could pump more liquidity into the financial system via so-called LTROs, or Long Term Refinancing Operations, to get credit flowing again between banks and businesses, crucial if any economic upturn is to be sustained.

The ECB already pumped more than €1.0 trillion (Dh4.6 trillion) into the banking system at the end of 2011 and the beginning of 2012 to avert a potentially disastrous credit crunch.