World Economy

S&P: Eurozone Needs $2.7t to Rid Deflation Threat

S&P: Eurozone Needs $2.7t to Rid Deflation ThreatS&P: Eurozone Needs $2.7t to Rid Deflation Threat

The eurozone will need at least another three years of quantitative easing and €2.4 trillion ($2.7 trillion) of firepower to revive its flagging fortunes, Standard & Poor's has warned.

With unemployment stubbornly high and growth still bouncing along the bottom seven years after the financial crisis, the European Central Bank will need more than double its €1.1 trillion bond-buying blitz launched earlier this year, said S&P.

The warning came as inflation fell back into negative territory for the first time in six months in September. Consumer price growth dipped to -0.1%, confounding analyst expectations after being pushed lower by a near 9% fall in energy prices. Core inflation–which strips out volatile elements such as energy prices–remained steady at 0.9%.

It is the first time deflation has come back to stalk the single currency after ECB Mario Draghi fought a protracted battle inside the bank to begin asset purchases to defeat the specter of low growth in March.

The ECB is expected to carry out its €60-billion-a-month asset purchases until at least September 2016, and has said it is willing to extend the program in the wake of turmoil in financial markets and fears over China.

Stimulus to Continue

But S&P's expectation that stimulus will continue into mid-2018 goes well beyond analyst predictions of a just a six-month extension. It would also more than double the current commitment to €2.4 trillion.

"Even in the best case, we believe inflation will still be well below the bank's target of close to 2%", said the rating agency.

"We wouldn't be surprised if the bank announced as early as December this year that it intends to extend its QE program well beyond 2016, until mid-2018, for a total that could reach €2.4 trillion, twice what was initially committed."

The stimulatory effects of euro-QE have been stymied in recent months by the rising value of the euro, notes S&P. The single currency has appreciated against the dollar in the wake of market uncertainty of a rate hike in the US.

Declining Prices

Falling energy and commodities prices, coupled with rising wages and employment in the region's most developed nations like Germany and Italy, contributed to the decline in the core prices index.

Currently, the ECB is planning to purchase the equivalent of $1.2 trillion in European assets before wrapping up stimulus in September 2016, but the volume of assets to be purchased might be increased in order to bolster prices.

The Eurozone's energy prices in September were 8.9% lower than a year ago. The prices index excluding food and energy is still flat at positive 0.9%.

Inflation in the Eurozone had hit positive 3% just before the debt crisis in 2011, and had steadily declined thereafter, dropping as low as negative 0.5% in early 2015. To address that challenge, the ECB enacted its stimulus policies in February-March 2015. Subsequently, the core prices index returned to positive territory, while previously-faltering growth accelerated as well. However, amid the currently significant growth, an expansion in policy stimulus might be too risky in terms of the eurozone's financial stability.

Amidst the anticipation of wider asset purchases by the ECB, investors have ditched the euro-denominated assets. The euro dropped 0.4% to $1.1205 and 0.7% against GBP. However, the euro is still on an upward trend due to Germany's massive current-account surplus.

Adding stimulus would be too risky for the region's financial stability, as the currently ultra-affordable credit and optimistic expectations in the economic performance are creating promising opportunities for asset speculators, rendering wild swings in assets value possible in the nearest perspective.

This outgoing month, the ECB was expecting the common area growth to accelerate to 1.7% in 2016, with inflation at 1.1%. It is quite likely the regulator will only add stimulus if economy fails to perform in accordance with such a scenario.

Losing Impetus

Despite some growth and inflation in the first half of the year there are signs the recovery is losing its impetus.

Some economists fear the slowdown in the Chinese economy could seriously damage the European and US economy.

On Wednesday the Bank of Spain said that it expected economic growth there to slow from 1% to 0.8% in the third quarter, and that the recovery in the jobs market had tailed off over the summer.

The prospect of deflation and a slowing economy increases pressure on the ECB to increase QE or carry it beyond September next year.

Timo del Carpio, European economist at RBC Capital Markets, said: "The [ECB's] governing council will look to cement expectations over the continuation of its asset purchase programs beyond their nominal end-date of September 2016.

"However, it may not be until the December meeting... that the governing council is prepared to make such a judgment."