On top of high unemployment and sluggish growth, the European Central Bank (ECB) has a new headache: an unexpected drop in inflation.
Most people think lower inflation is good news because it makes things easier to buy — and usually it is. However, the current slide is just another sign of how weak the economic recovery is in the 17 countries that use the euro.
An official report this week showed a surprise drop in the inflation rate to 0.7 percent in September from 1.1 percent the month before. That is well below the ECB’s stated goal of close to but below 2 percent that it considers ideal for the economy.
However, the monetary authority for the eurozone may be running short of tools to deal with the problem.
The drop in inflation shows demand is weak: People are not able or willing to risk spending or borrowing. Sellers cannot raise prices as much.
That remains the case in the eurozone, where unemployment is at a record of 12.2 percent and the economy only just emerged from a long recession with anemic growth of 0.3 percent in the second quarter. The worst outcome would be outright deflation. That is an economic death spiral, when a chronic fall in prices leads people to hold off spending because they know goods will become cheaper. Europe is still some distance from that.
Much of the downdraft comes from countries having the most trouble from the debt crisis. In Portugal, Ireland and Spain, inflation has been lower than the eurozone average — and prices even fell 1 percent in hardest-hit Greece in September. Wages fell in those countries, too. Labor cost increases have slowed in the eurozone as a whole, to an annual 0.9 percent in the second quarter.
The ECB has already used up most of its traditional medicine: lower interest rates. Its benchmark rate — what it charges to loan to banks — is at 0.5 percent, the lowest since the euro was introduced in 1999.
Yet a top ECB council member, Luc Coene of Belgium, has said an unexpected drop in inflation would demand a response.
A few analysts say the ECB might trim the benchmark rate again next week. Howard Archer, an analyst at IHS Global Insight, said the inflation figure had “moved the goal posts” and that a cut was “very much on the agenda.”
Besides trimming its benchmark refinancing rate, the ECB could bring its deposit rate — what it pays banks on money they keep with the ECB — below its current level of zero.
That would in theory push banks to stop stashing money at the ECB, but it could also backfire. Banks might simply pass on the cost to customers in the form of higher interest rates. And a negative rate could hurt bank profits at a time when regulators are trying to strengthen banks’ finances.