What the Latest Euro Zone CPI Figures Mean for ECB Policy

Nobody likes hearing the D-word these days but from the looks of the latest euro zone CPI estimates, deflation is back to haunt the region. Instead of printing a flat reading as analysts estimated, the annual headline CPI indicated a 0.1% decline in price levels for September.

As it turns out, falling oil prices ain’t done wreaking havoc in the euro region, as the components of the inflation report revealed that energy prices plummeted by 8.9% on a year-over-year basis. Yowza!

Euro zone CPI components

Source: Eurostat

Food, alcohol and tobacco showed a 1.4% gain, services contributed a 1.3% increase, and non-energy industrial goods chalked up a 0.3% uptick. This was enough to keep the region’s core CPI, which strips out the prices of volatile items such as food and energy from the calculations, steady at 0.9% as expected.

Why is this a big deal?

Since the central bank’s mandate is to maintain price stability, you can bet that ECB policymakers weren’t too pleased to find out that the headline CPI fell back in the negative territory after posting a few months’ worth of feeble gains. After all, deflation could convince consumers to delay their purchases in anticipation of cheaper price levels, leading businesses to lower their own prices in order to stir demand and boost sales.

While this might sound like good news to bargain-hunters and shopaholics like Happy Pip, shrinking profit margins for companies might force them to scale down production and hiring or eventually close shop. Now this type of situation is something that the ECB is keen on avoiding, especially since the euro zone has slowly started to get back on its feet over the past few months.

What can the ECB do about this?

During their monetary policy statement last month, ECB Governor Mario Draghi already mentioned that they’re open to expanding their stimulus program in order to ward off deflation. However, he has already anticipated that the CPI is likely to turn negative soon and emphasized that policymakers are willing to wait for more data before pulling the trigger on additional easing.

As it is, the ECB is already conducting asset purchases to the tune of 60 billion EUR each month in an effort to pump up liquidity and price levels. Some forex analysts say that the recent CPI estimates might be enough to push the ECB to step up its easing efforts before the end of the year while others say that inflation could pick up soon since oil seems to have bottomed out recently.

What does this mean for the euro’s forex trends?

All this talk of deflation and the prospect of further ECB easing has had the euro tossing and turning against its forex rivals in the past few weeks. Following the release of bleak preliminary CPI readings from Germany and Spain earlier in the week then the negative flash CPI from the region yesterday, euro bears seem to have come out of their cave and are on the hunt for more ECB easing clues.

With that, forex junkies are likely to keep close tabs on energy price movements to gauge whether or not this particular component is likely to put more drag on the region’s headline CPI. The ECB is set to announce its next monetary policy decision in October 22, just a few days after the revised CPI readings for September are released, so traders might be eager to price in their expectations until then.