Inflation Backs Draghi's Easy-Does-It Approach to Exit Talk

  • Euro-area price growth slowed to 1.4%, weakest this year
  • ECB Governing Council is preparing for June 8 Tallinn meeting

Mario Draghi has just received the ultimate piece of evidence that it’s too early to commit to an exit from monetary stimulus.

Two days after the European Central Bank president argued that ultra-loose policy was still needed to support the recovery, a report showed inflation slowed more than economists forecast in May. That’s despite a drop in unemployment to the lowest level in more than eight years and buoyant sentiment among consumers and businesses.

Draghi has tried to downplay expectations that the Governing Council will do much more than acknowledge the latest economic progress -- let alone put the ECB on an exit course -- when it meets next week in Tallinn. Actual evidence that price trends remain weak should help him hammer home the message that the central bank has to remain patient and quell the urge of some of his colleagues to take more decisive steps.

“A weaker number was to be expected,” said Natascha Gewaltig, an economist at Action Economics in London. “This backs Draghi, who doesn’t want to move too much in June, especially because the inflation path in their new projection is going to be weaker than it was in March.”

The ECB will publish updated economic forecasts next week. It currently predicts price growth of 1.7 percent in 2019.

Euro-area inflation decelerated to 1.4 percent in May -- the weakest reading this year -- from 1.9 percent a month earlier, Eurostat said on Wednesday. A measure that strips out volatile components such as energy and food fell to 0.9 percent, also weaker than expected. 

“Core inflation remains constrained by unemployment in many euro-area economies and by sluggish wage growth, even in the countries with better labor market conditions,” ECB Governing Council member Ignazio Visco said Wednesday in Rome. “A highly accommodative monetary policy is needed to achieve the full convergence of inflation to the ECB’s objective.”

Euro-area unemployment dropped to 9.3 percent in May, the European Union’s statistics office said in a separate release. While that’s the lowest level since March 2009, it includes wide variations within the currency bloc, including 11.1 percent in Italy and 3.9 percent in Germany.

Growth-Inflation Disconnect

IHS Markit, which publishes a monthly activity index, last week captured the disconnect between weak price growth and a strengthening economy where companies are stepping up hiring to meet demand. Growth -- envisaged to clock in at as much as 0.7 percent in the second quarter -- would be consistent with tighter monetary policy, it argued, if it weren’t for weakening inflation.

Price growth slowed more than anticipated in at least three major euro-area economies, even as sentiment indicators signal robust economic momentum.


ActualForecast
Germany1.4%1.5%
France0.9%1.1%
Italy1.5%1.5%
Spain2.0%2.1%

Draghi told the European Parliament on Monday that “downside risks to the growth outlook are further diminishing,” highlighting one of the key signals that the ECB could send next week. Some policy makers have said they now consider risks to the economy’s outlook as broadly balanced.

One of them is Executive Board member Sabine Lautenschlaeger, who argued on Wednesday in Berlin that “the recovery continues to firm and broaden, while the risks to growth, in my view, are now balanced.”

Executive Board member Benoit Coeure warned earlier this month that “too much gradualism” in adjusting the ECB’s policy stance bears the risk of larger market adjustments once decisions are finally taken, while defending the current plan to finish quantitative easing before raising rates. 

Bundesbank President Jens Weidmann, one of the fiercest critics of the central bank’s asset-purchase program, has argued that questions about the timing of an exit are legitimate.

Even so, both officials have defended the ECB’s accommodative stance. Their comments suggest that next week’s meeting may only yield relatively small changes to policy communication, such as the removal of an explicit pledge to cut rates further if needed or the recognition that risks to the recovery are no longer skewed to the downside.

“Draghi and others stressed that the most important argument for not considering an exit so far is that despite the surprisingly strong economy there were no signs of inflation rising on a sustained basis,” said Michael Schubert, an economist at Commerzbank AG in Frankfurt. “On balance, we are assuming that at next Thursday’s meeting the ECB will retreat in part but not entirely from its easing bias.”

— With assistance by Andre Tartar, Kristian Siedenburg, Lorenzo Totaro, and Chiara Albanese

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