Euro-Area Inflation Turns Negative for First Time Since 2016

Consumer prices in the 19-nation euro area are falling for the first time in four years, highlighting that a recent rebound in economic activity hasn’t managed to offset the pandemic’s profound impact on demand.

The inflation rate came in at -0.2%, missing economists’ median estimate for a reading of +0.2%. Core inflation hit a record low.

Part of the decline reflects discounting during summer sales, but the latest numbers are likely to sound the alarm for European Central Bank policy makers who have tried to soften the economic shock unleashed by the coronavirus.

In a warning sign for what lies ahead, a separate release showed that European factories cut jobs again in August, and reduced inventories of raw materials and semi-manufactured stocks instead of ordering supplies. Business is still driven by domestic demand, with export orders only rising modestly, according to a report by IHS Markit.

The ECB meets next week against a backdrop of improving consumption and industrial activity in the euro area, while millions of people remain out of work and businesses struggle to recoup months of losses. Another likely source of concern is the euro, which has risen more than 7% over the last six months.

The currency was little changed after the release, and traded up 0.3% at $1.1971 at 11:10 a.m. Frankfurt time.

Officials have already pledged more than 1 trillion euros ($1.2 trillion) worth of bond purchases through June next year in order to keep borrowing costs low. Whether or not more is in the cards is yet to be seen.

ECB chief economist Philip Lane said last week that the next step after fighting the shock is to stimulate inflation, and that policy makers stand ready to do more if needed. Executive Board member Isabel Schnabel said in an interview published Monday that incoming data don’t suggest a need for further action now.

On the surface, the numbers look more encouraging. IHS Markit’s Purchasing Managers’ Index indicated growth for a second month, with output expanding at the fastest pace in more than two years, and confidence improving.

The German government predicts the hit from the coronavirus crisis will be less severe than feared. It raised its forecast for GDP this year to -5.8% and lowered next year’s projection to 4.4%. Pre-crisis levels of output probably won’t be reached until the beginning of 2022.

“Manufacturing is currently being buoyed by a wave of pent up demand, but capacity is being scaled back,” said IHS Markit’s Chris Williamson. “The next few months’ data will be all-important in assessing the sustainability of the upturn.”

Uncertainty remains high that resurgent infections in many parts of the region will prompt new restrictions, keeping spending and investment restrained. High-frequency indicators tracked by Bloomberg Economics suggest the recovery pace is already slowing.

“Caution is warranted in assessing the likely production trend,” IHS’s Williamson said. “So far it would have been surprising to have seen anything other than a rebound in output and sentiment,” but “worryingly, order book growth cooled slightly in August, and there are indications that firms are bracing for a near-term weakening of demand.”

— With assistance by Kristian Siedenburg, Harumi Ichikura, and Simbarashe Gumbo

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