■ In January inflation decreased to 0.7%, matching the cyclical low of October 2013. The decrease was largely due to energy prices inflation, which fell by more than 1% y/y, after being stable in December. Alone, it deducted more than 0.1 pp to the change in headline inflation. Food prices inflation also declined, while the more domestically oriented core inflation inched up to 0.8% after losing 2 pp in December as a result of methodological changes adopted by the German Statics Office.
■ Will the ECB react as it did in November after the release of the inflation figures for October? Admittedly, there are some differences. Then, inflation was driven down by a fall in energy and food prices and more importantly by a sharp deceleration of core inflation, despite VAT increases in some countries should have pushed it up. This time the fall is mainly driven by base effects related to energy prices which should revert over the coming months.
■ Yet, the level of inflation is alarmingly low. At 0.7% the buffer against a negative shock is extremely small. As the Japanese experience taught us, it is extremely difficult to escape from deflation. The best strategy is avoiding it. This is way the ECB target for price stability is an inflation rate below but close to 2%. Cleary the ECB is missing its target.
■ At next week Governing Council meeting, a rate cut will probably be on the agenda. Given the division within the Council, this would be the action on which a consensus might be the easiest to reach reached. Some members will find the recent improvement of survey data encouraging as they suggest that the economy is recovering. Yet, its pace is extremely low, and it is not able to reabsorb the large mass of unemployed. At 12% in December, the unemployment rate is still close to its historical high of 12.1 of last summer.
■ Another factor which might favour an action on policy rates is the recent increase in the volatility in the money market following the reduction of excess liquidity. A cut in both the refi rate and the marginal lending facility rate might help countering the increase and the volatility of the Eonia. To sum up, the ECB Governing Council will clearly be on the spotlight next week.
BY Clemente DE LUCIA
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