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Draghi’s New Hurdle: Oil Price

Draghi’s New Hurdle: Oil PriceDraghi’s New Hurdle: Oil Price

Whenever Mario Draghi clears a hurdle on his path to higher inflation, a new one appears.

Just as the 19-nation economy sends encouraging signals that challenges from Brexit to terrorism won’t derail the modest recovery, a new decline in oil prices is casting a shadow over an expected pick-up in inflation. With growth not strong enough to generate price pressures, the European Central Bank president may have to revise his outlook yet again, Bloomberg reported.

Inflation remains far below the ECB’s 2% goal after more than two years of unprecedented stimulus and isn’t seen reaching it before 2018. Staff will begin to draw up fresh forecasts in mid-August, and while officials are in no rush to adjust or expand their €1.7 trillion ($1.9 trillion) quantitative-easing plan in September, economists predict Draghi will have to ease policy before the end of the year.

The UK’s vote to leave the European Union, the soundness of the region’s banks and a string of terror attacks from Germany to France dominated the public debate in the past weeks. Draghi and his fellow policymakers have worked to reassure businesses, consumers and investors that they would react to these shocks as needed while buying time to better assess the effects.

  Limited Impact  

Now, surveys suggest the impact of Brexit on the eurozone economy will be limited, with the recovery continuing at its slow but steady pace. Economic sentiment improved in July and a Purchasing Managers’ Index points to a slight acceleration in activity.

But a more familiar concern is rising to the fore: The price of Brent crude has fallen more than 13% since the UK’s June 23 referendum.

The drop may not be as severe as previous ones, which have seen the cost of oil plunge some 40% over periods of similar length. However, it is set to mute an inflation rate that was projected to pick up as effects of previous commodity-price declines peter out. The ECB currently sees consumer-price growth accelerating to an average of 0.6% in the fourth quarter, from 0.2% last month.

  Negative Effect

“Oil will have a modestly negative effect on inflation, revising the profile for inflation slightly downward,” said Frederik Ducrozet, an economist at Banque Pictet & Cie SA in Geneva. “Inflation is still likely to increase but it will be a very gradual and modest increase.”

The domestic economy probably won’t be able to contribute much. According to a recent ECB research paper, the gap between actual and potential output might have been as big as 6% in the past two years, compared with typical estimates closer to 2%. That would mean the economy has a long way to go until it reaches capacity limits and generates higher prices.

Core inflation, which strips out volatile elements like energy and food, stood at 0.9% in July. Gizem Kara, an economist at BNP Paribas in London, predicts the rate won’t rise but fall to record lows in the coming months.

 

Financialtribune.com