Limits to What Monetary Policy Can Do

The comments of ECB’s Rehn came in line with his colleague, ECB Vice President Luis de Guindos, as both agree that ECB should fight low inflation before Europe turns into “Japan”.

“We have learned from the experience in Japan that it is possible to get caught in a vicious cycle of declining inflation expectations, falling inflation and a binding lower bound on nominal interest rates from which it is difficult to escape”, as ECB Vice President Luis de Guindos stated.

Even without the pressure from policymakers, it is quite obvious that ECB must do something more than simply easing policy, as data keep adding pressure to the central bank’s concern that inflation expectations could become de-coupled. However, data over the last week but so far this week as well, backed Draghi’s decision to set easing measures despite the opposition from the core Eurozone countries.

The latest data releases from EU were the Services PMIs for September, with the overall reading, along with PPI inflation and Retail sales. Other than Retails Sales, all the rest of the economic data of the day pointed to a growing recession risk for the European economy, bringing vindication for doves ECB team and Draghi.

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Eurozone Services PMI revised down in final reading for September, while composite came out at just 50.1, signalling clearly stagnation and warning once again that the growing frailty in manufacturing sector has already started to affect other economic sectors. The retails sales rose up to 0.3% m/m in August, while along with a solid labor market, supported Eurozone’s consumption for Q3. Considering though all the other aspects of the economy, and the latest imposition of tariffs from US on EU, it is almost impossible to avoid the transmission of German manufacturing weakness across  labor market as well but in general across other sectors and countries within EU.

Germany has already entered technical recession as it contracted in Q2 and almost certainly did so again in Q3. Hence, on the background of Brexit uncertainty and further trade escalation, deep recession scenario for Germany and Eurozone gets closer.

The growing risk of stagnant economic conditions to turn into recessionary could defend the restart of asset purchases and the push from ECB to governments for implementing fiscal support to strengthen the economy.

Andria Pichidi, Market Analyst at HotForex

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