A pick up in Eurozone inflation, a good thing or not?

When the Eurozone flash CPI data for April is released  on Wednesday this week, Mario Draghi and the ECB will potentially have the next stone laid on the road towards Quantitative Easing.

However, there are several significant questions that the recent data poses. How long might the road be? Also, is Eurozone QE just Mario Draghi’s latest magic trick (remember the ECB’s Outright Monetary Transactions programme, the ECB will do “whatever it takes”)?

It has now got to the stage that it seems to be never more than a few days between various ECB members talking about the use of QE to tackle persistent low inflation. However, the forecasts suggest that ECB inflation for April will increase from 0.5% to 0.8%. For the Eurozone, would this be good news or not?

The recent flash PMI data suggests that the Eurozone economic activity is gradually picking up, but only gradually. GDP growth of 1.2% is predicted for 2014, but unemployment in the region remains too high at around 12%. Credit creation in the Eurozone is a huge problem, with the banking sector in the Eurozone going through a huge deleveraging exercise. In February, the 2.2% year on year decline in private loan balances in the Euro area was worse than expected, with maturing loans not being replaced by new credit.

Furthermore, the ECB’s Asset Quality Review (a stress test of the banks) is discouraging credit expansion and is putting added pressure on banks to shore up their balance sheets, with lenders reluctant to take on more risk. Sustainable growth will be a significant struggle in the absence of accommodative bank credit growth.

The concern is that inflation begins to pick cyclically and the ECB gives a big sigh of relief. Attempts at jawboning the Euro lower may keep a lid on the Euro/Dollar at $1.4000 but the longer term ramifications for the Eurozone could be significant. There have been comparisons between Japan in the 1990s and the Eurozone today. Back then, Japan then did too little too late to combat deflation and a lost decade was the result. The fear is that the Eurozone could be in the same situation.

Richard Perry, Market Analyst at Hantec Markets