Euro-Area Inflation at 0.7% Builds Rate Pressure on ECB

Euro-area inflation remained below half of the European Central Bank’s target in January, driven by falling energy prices, adding to the case for policy makers to cut interest rates next week.

Consumer prices rose an annual 0.7 percent after a 0.8 percent gain in December, the European Union’s statistics office in Luxembourg said today. The median estimate in a Bloomberg News survey of 41 economists was for an increase to 0.9 percent. That’s the fourth consecutive reading of less than 1 percent. The Frankfurt-based central bank aims to keep inflation at just under 2 percent.

German 2-year bond yields fell to the lowest since November yesterday after inflation in Europe’s largest economy also came in below economists’ expectations. President Mario Draghi unexpectedly cut the benchmark rate to a record-low 0.25 percent in November after inflation slowed to 0.7 percent.

“Although we do not expect the region to fall into outright deflation, the euro zone is becoming increasingly vulnerable to such an outcome in case of a new unexpected demand shock,” said Nick Kounis, head of macro research at ABN Amro Bank NV in Amsterdam. “We expect the ECB to take action to ease monetary policy, possibly as soon as next week’s meeting.”

The euro extended losses against the dollar after today’s data were released, trading at $1.3520 at 2:21 p.m. in Brussels, down almost 0.3 percent on the day.

Youth Unemployment

Energy prices fell 1.2 percent after stagnating in December, according to today’s report. The core inflation rate, which strips out volatile items such as energy, food, alcohol and tobacco, rose to 0.8 percent from 0.7 percent.

The euro-area unemployment rate held at 12 percent in December, a separate Eurostat report showed today. That’s down from a high of 12.1 percent in September. Unemployment among young people declined to 23.8 percent from 24 percent.

“There is growing evidence that unemployment has reached its peak and in many countries is now falling,” European Union Economic and Monetary Affairs Commissioner Olli Rehn said at a conference in Brussels today. “The doomsday prophets have been proven wrong, but we cannot claim victory.”

The ECB predicts the currency bloc’s economy will grow 1.1 percent this year and 1.5 percent in 2015, and policy makers have indicated that a few months of low inflation may not necessarily trigger further monetary-policy action.

EBA Stress Test

Lending to companies and households contracted for a 20th month in December, the ECB said this week, and Vice President Vitor Constancio said that the central bank’s review of banks’ balance sheets this year may harm the nascent recovery.

The European Banking Authority said today that the region’s largest banks will have to show their capital won’t dip below 5.5 percent of their assets in an economic crisis as part of its own stress test, with results to be published in October.

Dutch central bank governor Klaas Knot said in a Bloomberg interview that annual consumer-price gains will probably stay below 1 percent until May or June. The ECB’s December projections foresee annual inflation rates of 1.1 percent this year and 1.3 percent in 2015.

“We have to look at it from a medium-term perspective and, so far, this is quite in line with our baseline scenario,” Draghi said on Jan. 9 after the Governing Council kept borrowing costs unchanged. “We will act when we have reason to think that our medium-term assessment for inflation is changing for the worse.”

‘Unwarranted Tightening’

German inflation unexpectedly held at 1.2 percent in January, with consumer prices dropping the most in a year when compared to the previous month, according to data published yesterday. Economists had expected the rate to increase to 1.3 percent.

Another key to any action will be officials’ interpretation of the “unwarranted tightening” in money markets that Draghi said would be one reason to ease policy.

The overnight unsecured lending rate for banks was above the ECB’s benchmark rate for four days through Jan. 21 and climbed as high as 0.359 percent on Jan. 20. It fell to 0.157 percent by Jan. 29.

“With regard to money-market conditions and their potential impact on our monetary-policy stance, we are monitoring developments closely and are ready to consider all available instruments,” Draghi said on Jan. 9.

Economists at Commerzbank AG and Barclays Plc changed their interest-rate call this month and now expect the benchmark rate to fall to 0.1 percent and the deposit rate, which is currently at zero, to minus 0.1 percent by March. Policy makers hold their next meeting on Feb. 6.

“Further monetary easing on the back of a renewed downgrade in the inflation outlook can certainly not be ruled out,” Martin Van Vliet, an economist at ING Bank in Amsterdam, said today. “If we were to start to see a slowdown in the recovery, or a relapse in the recovery, or a strengthening of the euro, that could be a trigger.”

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