ANALYSIS: Eurozone Inflation Drop Adds Pressure on ECB

Brussels (AP) -

After breaking out of recession and taming its financial crisis, Europe now faces a new kind of economic threat — deflation, a protracted drop in prices that can snuff out growth for years.

New data released Monday showed the inflation rate fell in March to its lowest level since the 2008-2009 global financial crisis, a sign of economic weakness that piles fresh pressure on the European Central Bank to further ease its monetary policies this week.

Inflation across the 18-country eurozone dropped to 0.5 percent, the Eurostat statistics agency said, down from 0.7 percent in February and below forecasts for 0.6 percent.

The steady decline, the third in as many months, raises concerns that consumer prices may start to fall outright. That risks creating a situation in which consumers and businesses put off purchases in hopes of better deals down the line and companies cut prices to entice buyers.

Such a downward spiral chokes off economic growth and can be difficult to get out of — Japan was stuck in deflation for two decades.

Aware of such danger, the ECB has said it stands ready to act. However, analysts are divided over whether it will do so at this month’s meeting on Thursday. While some note the ECB has said it does not expect deflation in the eurozone, the new figures might force its hand.

“The ECB may have little option but to take further policy action,” said analyst Ben May of Capital Economics.

In Europe, the inflation rate is the main driver of monetary-policy decisions — unlike in the United States, where the Federal Reserve also takes unemployment figures into account. The ECB aims to keep inflation close to, but just below, 2 percent.

The dip in inflation comes at a time when the euro has been buoyant in foreign exchange markets. A higher currency can push inflation down in two ways: It can make imports cheaper and weigh on economic activity by making exports more expensive on international markets.

Some countries, like Spain, the eurozone’s fourth-largest economy, are already seeing consumer prices fall.

Market reaction on Monday was mild, however, with the euro actually rising. A currency usually weakens on the prospect of looser monetary policy.

That may be because the ECB had itself warned of a bout of weak inflation, trimming in February its inflation forecast for this year to 1 percent. It did not predict deflation, however, as the economic recovery slowly gains strength.

Also, economists note that the drop in inflation in March can partially be attributed to certain seasonal-related issues in effect this spring.

However, most experts say Monday’s data adds pressure on the central bank to act at some point in coming months.

“At its meeting on Thursday, we would expect the ECB to at least shift its language to acknowledge that the current trend in prices is of concern,” said analyst Tom Rogers of Ernst & Young.

Interest rates are already at a record low of 0.25 percent, so some analysts argue the bank could resort to less-conventional measures to ease its monetary policy.

Among the possibilities cited is a new round of cheap loans to banks. A more far-reaching measure would be large-scale purchases of financial assets such as government bonds with newly created money, as the U.S. Federal Reserve has done.

That would increase the amount of money in the economy and aim to lower market interest rates and stoke inflation. But such a move faces legal, political and technical obstacles.

The ECB could also trim its deposit rate below zero, effectively penalizing banks for holding money at the ECB instead of lending it out in the economy.