The Euro Puts Deflation Behind It

By Hunter Bosson          

On March 9th, Mario Draghi signaled the end of the Eurozone's deflationary fears riding on its currency exceeding inflation targets for the first time in four years. The announcement came two years after the European Central Bank began its trillion-Euro Quantitative Easing policy to fend off deflation, a strategy the ECB partially credits with the Eurozone’s monetary turnaround. More important was what Draghi did not say, as he dropped any reference to the “use of all the instruments available in its [the ECB’s] mandate” to further its expansive monetary policies. Although Quantitative Easing (QE) will run until to at least the end of the year, and the rate on deposits at the ECB is still negative, it appears that the days of unconventional monetary policy may be fading for the ECB as the economy continues to improve.

The European markets are currently embraced by a mood of tempered optimism with the Euro jumping 0.9 percent against the dollar following the news. The ECB even raised growth projections from 1.7 to 1.8 percent. Although the ECB predictably declined to raise rates in March, debate has sprung up as to whether the ECB should raise rates before ending its QE program. Already the ECB has to contend with German monetary hawks resisting the temptation to let inflation creep higher.

            Projections should be taken with a grain of salt. As Draghi was quick to point out Eurozone inflation was lifted by high energy prices; core inflation is still only 0.9 percent, essentially unchanged since 2015. Such tepid improvements suggest the ECB will not be raising rates until later this year at the earliest. Still, even the possibility of rate rises in the next year marks a large departure from the outlook earlier this year.

Perhaps the greatest cause for continuing concern among potential Euro purchasers remains the political uncertainty surrounding member nations. With French hyper-nationalist and Eurosceptic Marine Le Pen polling second in the country’s Presidential race, there is a sense of general unease in Brussels. Although still seen as a long-shot candidate, her promise to pull the Eurozone’s second largest economy from the shared currency is sufficiently apocalyptic to keep investors cautious. Europeans are understandably jittery as far-right parties have waged a successful political insurgency in the last year while their greatest military and economic partner America, succumbs to the ruminations of a narcissistic kleptocrat. Fending off deflation will do little to ease the pain if the Eurozone collapses under the weight of paranoid Euroscepticism. But after the past 12 months, with Brexit in the UK and Trump in America a reality is anything beyond the scope of possibility?