Mario Draghi Copyright Thomas Lohnes, Getty Images

European Central Bank President Mario Draghi speaks during a December press conference.

Threat of German Deflation Boosts Case for ECB Action

Such concerns already have persuaded the European Central Bank to cut interest rates to a new all-time low and roll out a series of asset purchase programs to inject cash into the economy.

Inflation in Germany, Europe's biggest economy, hit a five-year low in December, data showed Monday, turning up the heat on the European Central Bank to do more to ward off the threat of deflation, analysts said.

In a preliminary flash estimate, the federal statistics office Destatis calculated that German inflation stood at just 0.2% year-on-year last month, down from 0.6% in November. 

The last time inflation in Germany was lower than 0.2% was in October 2009. 

Taking 2014 as a whole, inflation stood at an annual average 0.9%, Destatis calculated.  

Using the Harmonized Index of Consumer Prices (HICP) -- the ECB's yardstick -- inflation in Germany was even lower at 0.1% in December, way under the central bank's target of just below 2%.

The sharp slowdown in inflation in Europe's biggest economy will fuel fears that prices across the entire eurozone could begin falling and tip the region into deflation -- a sustained and widespread drop in prices that hampers economic activity and could lead to job losses.

If inflation is too low for too long, then it can happen that people will bet on a further fall in prices and postpone spending.

— Mario Draghi, European Central Bank president

While falling prices may sound good for consumers, deflation can trigger a vicious spiral in which businesses and households delay purchases, throttling demand and causing companies to lay off workers. 

Such concerns already persuaded the ECB to cut interest rates to a new all-time low and roll out other anti-deflation measures such as a series of asset purchase programs to inject cash into the economy.

But if euro areawide inflation turns negative, then the ECB may have to resort to even more radical measures, such as so-called quantitative easing (QE), the large-scale purchase of sovereign bonds, analysts said. 

"For the ECB, such low inflation rates in Germany should make it easier to argue the case of further monetary easing," said Berenberg Bank economist Christian Schulz. 

The ECB is scheduled to hold its first policy meeting of this year on Jan. 22, and there is already widespread speculation that ECB chief Mario Draghi may announce some sort of QE program, despite opposition from the likes of the Bundesbank or German central bank.

Potential for Deflation is "Limited"

Critics see QE as a license to print money to get governments out of debt, which the ECB is strictly forbidden from doing under its statutes. 

In a recent interview, Draghi insisted that the danger of deflation was "limited," but "cannot be ruled out completely."

"If inflation is too low for too long, then it can happen that people will bet on a further fall in prices and postpone spending. We haven't reached that point yet. But we have to prepare for that risk," Draghi said.

Commerzbank economist Marco Wagner said the inflation data could force the ECB's hand on Jan. 22.

"We expect the ECB to announce broad-based government bond purchases," he said. 

But ING DiBa economist Carsten Brzeski said a combination of falling inflation and the latest crisis in Greece would put the ECB in a quandary. 

The possibility of Greece rescinding on its austerity commitment and quitting the single currency "probably encouraged QE opponents at the ECB to increase their resistance," Brzeski said.

At the same time, negative headline inflation "would clearly feed deflationary fears of the QE proponents," he said. 

Natixis economist Johannes Gareis said the inflation data "add weight to our view that the ECB will embark on full-blown QE at its next meeting on January 22." 

Copyright Agence France-Presse, 2015

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