#UK Cheap oil has ECB over a barrel


On paper, low oil prices should be positive for the economy because they boost purchasing power, but in the current environment, they could also be seen as a sign of slowing demand

Frankfurt (AFP) – Falling oil prices can be both a boon and bane for the global economy, but for the European Central Bank they are now a major headache because they are keeping eurozone inflation much lower than it would like.

On paper, low oil prices should be positive for the economy because they boost purchasing power.

But in the current environment, they could also be seen as a sign of slowing demand, observers argue, posing a challenge for the ECB’s monetary policy and putting its credibility to the test. 

“The weakening of oil prices is currently the most important factor in the ECB’s analysis,” ING DiBa economist Carsten Brzeski told AFP. 

Low oil prices were pushing inflation lower and fuelling concerns within the ECB’s governing council about the threat of deflation, or a downward spiral of falling prices, the expert argued. 

So far, the drop in oil prices — 60 percent since mid-2014 — has been seen by many central bankers and economists as a result of over-abundant supply, helping to slash energy bills for households and businesses alike.

But the ECB’s own chief economist Peter Praet said in a recent interview with Bloomberg News that a “significant” part of the decline was attributable to the slowing global economy. 

“A lot of the latest wave of commodity price declines is demand related. At some point in the recent past you had a supply side issue, which is a windfall for consumers, but now a significant part is also coming from weak global conditions,” he said. 

ECB president Mario Draghi put forward similar arguments at the end of October. 

And a global economic slowdown could undermine the still very tentative recovery in the 19 countries that share the euro. 

For the ECB’s part, “it’s tactically smart to focus the debate on demand shocks”, said Gilles Moec at Bank of America.

“But the real problem for the central bank is whether it remains credible or not,” he said. 

“Markets’ inflation expectations have fallen sharply,” he noted, pointing out that only time could tell whether they would prove correct.

– Bank is ‘powerless’ –

But the ECB is concerned that the pessimism of market players reflects a lack of confidence in its ability to counter future oil price shocks, Moec said. 

Praet hinted as much himself.

“We have seen, on occasions, longer-term inflation expectations responding to short-term movements in oil prices. That is unacceptable for a central bank, insofar as it implies that people’s expectations of its reaction function have become less certain,” he said. 

The ECB has unleashed an unprecedented series of policy measures to try and push eurozone inflation back up to levels conducive to healthy economic growth. 

It has slashed key interest rates, made vast amounts of cheap loans available to banks and most recently embarked on a programme to buy around 60 billion euros of bonds each month until at least September 2016. 

But area-wide inflation is still chronically low, standing at just 0.1 percent in October, far below the ECB’s target of just under 2.0 percent. 

November inflation data are scheduled to be published on Wednesday, with analysts pencilling in a meagre 0.2 percent. 

In view of this, the ECB’s governing council is expected to announce a stepping up of the asset purchase programme at its meeting on Thursday, and possibly even a further cut in key interest rates, already at historic lows. 

“Inflation has now been below target for a long period of time and even probably the most optimistic  forecasts suggest that it could well be quite some time before inflation returns to target,” said Oxford Economics analyst Ben May.  

“There’s not much the ECB can do to control the oil prices. So to a certain degree, the ECB is powerless,” he said. 

But for the ECB’s chief economist Praet it was “essential that uncertainty does not give rise to indecision”.

In other words, in order to safeguard its credibility and give the impression that it remains in control, the ECB should not hesitate to act. 

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