Euro drops to 4½-year low as Draghi hints at more stimulus

Shares too fall after ECB chief says ready to act on low inflation…

A strong indication on Friday that the European Central Bank (ECB) is on the verge of aggressive action to stimulate the economy, just as the Federal Reserve is dialing back its stimulus, has pushed the euro to its lowest against the dollar since 2009.

ECB president Mario Draghi said in an interview published in the German newspaper Handelsblatt that the risk that the central bank would not be able to meet its goal of keeping inflation from being too low or too high was greater than it was six months ago. At 0.3% in November, inflation in the euro zone was far from ECB’s 2%target.

Draghi said there was a risk that low inflation could delay people from making purchases. If so, that would be a classic symptom of deflation.

The risk of deflation “cannot be ruled out completely, but it is limited”, Draghi said. But he added: “If inflation remains low for long, people might expect prices to fall even further and postpone spending. We are not there yet.”

The euro fell to 1.20 against the dollar on Friday as Draghi’s comments reinforced expectations that the ECB would soon begin large-scale purchases of euro-zone government bonds, or quantitative easing, a programme intended to further drive down borrowing costs when official rates are already near zero. The weaker euro is a mixed blessing for the struggling eurozone economy. European exporters will gain a competitive advantage against foreign rivals because their products will become cheaper for customers who pay in dollars or other currencies that tend to track with the dollar.

A weaker euro could also push up inflation — a desirable outcome at the moment — because foreign goods would become more expensive in euro terms. Many analysts expect inflation to have fallen below zero in December from 0.3%.

However, a weaker euro also has negative effects. Because oil is usually priced in dollars, a weak euro cancels out some of the economic benefit from the recent drop in oil prices.

Cheaper energy is good for companies because it reduces production costs for factories. Consumers benefit because they pay less for fuel and can spend the money on other things. “Low inflation is already a serious obstacle to economic recovery and rebalancing within the eurozone,”

Jean Pisani-Ferry, an economist who serves as a policy adviser to the French government, wrote in a blog post this week. “Outright deflation would be an even more dangerous threat.”

And if the central bank were to hold its fire now, Pisani-Ferry wrote, the consequences for the financial system would be disruptive, as investors have already factored in quantitative easing. Disappointing those expectations would bring “an abrupt and damaging unwinding of positions:

Long-term rates would rise, stock markets sink, and the exchange rate appreciate,” he wrote.

Draghi’s comments were part of an ever-louder drumroll from top ECB officials signalling that quantitative easing could come as soon as the next monetary policy meeting, on January 22. “There are growing indications that the ECB will decide as early as January to buy government bonds on a large scale,” Ralph Solveen, an economist at Commerzbank, wrote in a note to clients on Friday.

Peter Praet, a member of the central bank’s executive board, said in an interview published on Wednesday in Börsen-Zeitung, a German financial newspaper, that oil’s slump “could mean negative inflation during a substantial part of 2015”. “There is the risk that we won’t have achieved the degree of monetary accommodation that we had intended,” Praet said. “This is why we have to be very vigilant and ask ourselves: Have we done enough?”

By speaking to German newspapers, Draghi and Praet may have been trying to weaken resistance in the German public to central bank bond buying. Many Germans fear that they would be stuck with the bill if some euro-zone countries like Greece or Italy were unable to pay their debts. Among the 25 members of the central bank’s Governing Council, which sets monetary policy, there appears to be a majority in favour of beginning quantitative easing immediately. But the council might wait until March, when it holds its second monetary policy meeting of the year, in order to persuade reluctant members from Germany and some other countries.

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