Eurozone inflation slowdown dampens prospects of tighter monetary policy from ECB

Jasper Jolly
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Mario Draghi has been firm in his accommodative stance (Source: Getty)

Inflation in the Eurozone slowed dramatically in March despite new figures showing fuel and food were the main drivers of price increases, making tighter monetary policy from the European Central Bank (ECB) an even more remote possibility.

Consumer prices rose by an annual rate of 1.5 per cent in March, down from two per cent in February, the European Commission confirmed.

The biggest contributors to inflationary pressure were transport fuel, heating oil and vegetables, none of which are included in the core inflation index basket.

Read more: Fall in Eurozone inflation boosts dove Draghi

Core inflation, which strips out the effects of those volatile components, fell to 0.7 per cent for the same period.

While the ECB targets headline inflation of two per cent, the central bank's president Mario Draghi has repeatedly made it clear it will watch core inflation until it judges prices are rising at a sustainable rate.

The core inflation rate does not include energy prices or food, which can swing wildly from month to month. The biggest contributors to headline inflation were fuel for transport, heating oil, and vegetables, supporting the ECB's contention price rises will slow further once the effects of rising oil and food prices feed through completely.

The ECB's governing council meets next Thursday to decide monetary policy, but economists almost universally believe the central bank will not act to tighten the supply of money until at least December, when the current quantitative easing bond purchase plans end.

Read more: Eurozone inflation just hit two per cent for the first time in four years

Core inflation will rise sharply next month to one per cent as timing effects lapse, but not enough to prompt a reversal in loose monetary policy from the ECB, according to Claus Vistesen, chief Eurozone economist at Pantheon Macroeconomics.

He said: "Food and energy inflation will continue to decline in coming months, but the core rate will snap back sharply in April as the Easter effect reverses."

He added: "Going into next week’s ECB meeting, these data support the governing council's resolve to look through a 'temporary' increase in headline inflation."

How to understand the European Central Bank's interest ratesĀ 

The European Central Bank (ECB) has three rates:

  • The main refinancing operations: what banks pay to borrow from the ECB

  • The rate on the marginal lending facility: the rate at which banks lend to each other overnight

  • The deposit facility: the rate banks receive to leave money with the ECB overnight

The ECB has kept interest rates unchanged since March 2016, when all three were cut. They have since stayed at zero per cent, 0.25 cent and minus 0.40 per cent respectively.

If a rate is negative the bank will pay the ECB (rather than receiving money in interest). Negative rates are intended to encourage banks to lend money to businesses rather than holding it themselves or, as is the case with the deposit facility rate, depositing it with the ECB overnight.

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