Eurozone CPI evidence that ECB won’t be announcing full-blown QE and rate cuts

3rd June 2014

Eurozone CPI – 03/06/14

Eurozone headline inflation of 0.5 per cent in May has effectively sealed the deal for ECB easing, with the stark deviation between the target of just below 2 per cent locking the Bank into further easing at their June meeting this Thursday.

The headline CPI sunk back to the levels seen in March, when the timing of Easter gave the central bank a convenient excuse to put off easing. After Draghi signalled at the May press conference that the Governing Council was simply waiting for further news on inflation and was comfortable acting next time around, the stakes are certainly high for words to be put into action.

The detail of the inflation report provides vindication for the Bank’s assertion that external market prices, and particularly a weaker Euro, are behind lacklustre inflation, rather than an endemic fall in demand. This is further evidence that the ECB will not be announcing full-blown QE and rate cuts, including negative deposit rates, are the most likely option in tandem with measures to correct constrained credit supply.

More telling than the figure itself was the reaction to it, as markets immediately took profits on bets that CPI would undershoot and ECB action would be a shoe-in. In fact, the Euro actually rose higher after the inflation data.

Today’s price action was a litmus test of how markets are positioned ahead of Thursday’s key decision and it suggests markets are dangerously positioned to profit take on any ECB announcement. The ECB is almost set up to fail and it will take an arsenal of monetary policy weapons to achieve Draghi’s ultimate aim: for the Euro to actually weaken following the announcement.

The ECB faces a lose-lose situation going into Thursday’s policy meeting and the Council will have to pull off another ‘OMT Magic Moment’ if they are to achieve their aim of a weaker Euro.