Monthly Archives: September 2016

Eurozone Struggles To Break Free Of Deflationary Trap

Mario Draghi, Chief of the European Central Bank (ECB), has struggled to keep the Eurozone on a path out of the deflationary trap it has been stuck in for the past two years. While European inflation is positive, it is not as stable as many investors would like it to be. In fact, large sections of the Eurozone only appear to go deeper into a deflationary trap as the months progress.

Since 2014, the European Central Bank has taken several radical steps to avert the continued downward spiral of the Eurozone. None of these actions have seemed to produce the desired results. Negative interest rates introduced in 2014 have proven ineffective when it comes to halting the deflationary spiral. The ECB was the first central bank to use that strategy. The ECB chief also introduced the printing of money in order to boost deflation.

With one trillion Euros invested by the central bank, consumers could have expected a dramatic turnaround. That has not yet been seen. Instead, the currency bloc is lacking adequate protection against any type of recession, including the global recession which some experts feel may take place soon. Earlier in 2016, central banker William White, who also predicted the 2008 crisis, warned that an explosion in debt could bring about a worldwide crisis soon. France, like Italy, is at a standstill in terms of growth and the zone is certainly vulnerable to any sort of outside shock.

People all across Europe are in a position of constant uncertainty. One day they may hear that things are looking up and the next, they are told to tighten their belts since growth is a thing of the past. The ECB has seemed to exhaust almost all of its resources. It is constrained both by what has seemed to work in the past as well as its legal mandate. Right now, some consumers are worried that it may be unable to do more to stop the downward spiral in economic growth.

Consumer prices have been stuck at under 1pc throughout 2016. Mario Draghi has clearly identified over 1pc as his ideal limit for the zone. However since July, prices have remained at less than 0.5pc, putting them firmly in the danger zone demarcated by the chief of the ECB. This puts immense pressure on the ECB, which has a target of 2pc set for the single currency area.

With added uncertainty due to Brexit, the ECB has stated that it is unlikely to meet its goal of 2pc in 2016. In fact, that particular inflation target may not be met until after 2020. They are placing increased pressure on governments to do what is necessary to break the zone out of the deflationary cycle.

Many governments throughout the Eurozone are worried about the low levels of inflation, since that makes consumers delay spending. Even worse, debts are more difficult to repay when deflation occurs. With an area as large as the Eurozone, its deflationary spiral can have a negative effect on debt prepayment worldwide, further increasing the chances of a global recession at some point.

Nicholas Spiro is one expert who feels that Mr. Draghi has run out of options. The sovereign bond strategist thinks that it is up to the ECB to develop strategies which are suited to the struggling economies in Europe. He feels that monetary policy is what will bring the Eurozone back from the brink, not the actions of individual governments.

The central bank has not yet confirmed whether its bond purchases programme will be extended further. Some strategists are hopeful that it will last longer than March 2017. The US Federal Reserve has pointed out that stopping action in 2017 would effectively amount to monetary tightening, which would have a detrimental effect on inflation in the zone.

While Mr. Draghi has pulled out all the stops to prevent deflation, inflation has not passed 1pc in the last three years. The underlying trends worry officials, with the percentage of goods and services in the consumer basket that are below 1pc increasing to 58%. Forex providers such as CMC Markets are watching the developments carefully, in order to offer the best options to their clients. Their solutions allow clients to benefit in both rising and falling markets.