The Eurozone has entered the red zone - CNBC Comment

The ECB may not be forced to act until we see outright deflation
The Eurozone's August inflation figure was confirmed at 0.3 per cent last week, down from July’s surprisingly weak reading of 0.4 per cent. It was also, of course, way below the European Central Bank’s (ECB) inflation target of just under 2 per cent, and well within the ECB’s stated “danger zone” of under 1 per cent.
This week is an important one for the markets. The ECB meets on Thursday, and investors are still betting on whether it will roll out more stimulus. Just over a week ago, Mario Draghi spoke at the annual Jackson Hole Symposium, indicating that the ECB might act – all depending on the Eurozone inflation data. But while the head of the ECB provided a more dovish line, causing the euro to drop, a report from Reuters, quoting unnamed sources, stated that the ECB might not act – all depending on the Eurozone inflation data. This caused the euro to rise. In essence, they were stating the same thing: “the ECB’s actions depend on the inflation data.”
So will the ECB act? Peter Rosenstreich, chief foreign exchange analyst at Swissquote Bank, thinks not. Instead, it will opt to wait for more of the effects of its June policy decision, where the ECB announced targeted long-term refinancing operations (TLTROs).
TLTROs are officially conducted this year on 18 September and 11 December, and Rosenstreich says it will be important to see how many banks decide to participate in the offering. He also points out that, while the real caveat remains inflation, we’re already in the red zone from a data perspective. He thinks it’s almost inevitable that we will see quantitative easing in Europe. But with resistance towards full blown QE from former ECB head Jean-Claude Trichet and the German Bundesbank, the green light to go down this path is perhaps not as green as thought.

WHERE IS THE EURO HEADING?

When it comes to the euro, Rosenstreich thinks we could see some short-term wobbles but euro-dollar will still be stuck in a trading range of $1.34-$1.31 if the ECB decides not to act on Thursday. And he sees this continuing until we see outright deflation. At the moment, Draghi probably doesn’t see that much of a difference between 0.2, 0.3 or 0.4 per cent inflation, but were it to turn negative, the ECB would be forced to act immediately. Rosenstreich thinks there is a big chance the euro will be weaker by the end of 2014, trading around $1.30-$1.32, and through next year he anticipates significant weakening down to $1.25, as the gulf of recovery widens even more between the US and Europe. Ultimately, if the US Federal Reserve and the ECB both act, that would really damage the euro.

City A.M.'s opinion pages are a place for thought-provoking views and debate. These views are not necessarily shared by City A.M.

Related articles