Sound bites: Eurozone inflation at 1.2% a clarion call for immediate ECB rate cut

Eurozone inflation dropping to 1.2% is a shocking testament of policy failure by the ECB. Low and falling Eurozone inflation marks a clarion call for an immediate ECB rate cut this week. There should be no delay. Based on the ECB’s myopic inflation targeting, Eurozone monetary policy settings are far too tight. It is no wonder that the Eurozone economy has been steeped in recession for so long. Some parts of the Eurozone economy are even in deep danger of falling into depression without prescriptive policy action soon. The fact that inflation has fallen so sharply below the 2% target and that core inflation has been stuck below 2% for a decade, underlines the contingent risks ahead. Without a sharp reversal of policy across the board – monetary and fiscal – the survival of the Eurozone is at deep risk. The key is how long before disinflation (slowing inflation) turns into deflation (falling prices). Unless the ECB changes course soon, the Eurozone could soon be following Japan down the road to a decade of deflation and economic underperformance. Unless Eurozone policy starts to pull things together soon, the risks are the euro area could pull apart as growing economic and political strains set in.

There should be no hanging about this week. Draghi has already earmarked a rate cut soon and no better time to deploy it than this week. If there was ever a good reason for the ECB to cut at this week’s rate policy meeting, it would be a show of independence in the face of some blatant political interference from Germany’s Merkel to stop another ECB rate cut. Her argument for higher rates being appropriate for Germany at this juncture are completely out of place for a Eurozone that is in desperate need of extra stimulus right now. Her remarks will be counterproductive as they will probably forge a unity outside the German bloc for a quick and immediate cut.

A rate cut this week should only be the beginning. The ECB needs to follow through with unremitting waves of new liquidity - in conventional and unconventional form. The ECB needs to wake up to the exigencies of the debt crisis and extend the liquidity reaching the banks through to consumers and industry as much easier credit. The latest Eurozone money supply data underline that where domestic credit should be expanding, it is doing the opposite and contracting. An expansive credit policy combined with pro-growth fiscal stimulus is the only way to guarantee sustainable growth going forwards for the Eurozone. The ECB and Eurozone governments need to start working in tandem very quickly.

The weak inflation picture in the Eurozone highlights a major policy failure by the ECB. Inflation well below target and the economy in recession are the litmus tests that the ECB are not doing enough and it is time to start getting the recovery back into gear with another rate cut and more monetary intervention very soon.