Eurozone continues to disappoint

October 11th, 2012

According to, the European Central Bank (ECB) should keep interest rates low for the foreseeable future and may need to cut them further given the risk of deflation.

European inflation will slow to 1.6 percent in 2013. “The probability of falling prices is unusually high, reaching almost 25 percent. This projection gives the ECB ample justification for keeping policy rates very low or cutting them further,” said the International Monetary Fund.

While the ECB cut its benchmark interest rate to a historic low of 0.75 percent on July 5, ECB President Mario Draghi signaled last week that further easing may only have a limited effect on the economy.

Unless the ECB’s announcement of an unlimited bond-purchase plan is followed up with more proactive policies, the latest economic projections may once again prove overly optimistic.

The ECB’s bond-buying plan, which pledges unlimited support for countries that sign up for economic reforms as part of a bailout from Europe’s rescue fund, will help transmit monetary policy to the affected regions.

Still, according to Bloomberg, “the possibility that the euro-area crisis will escalate remains a major downside risk to growth and financial sector stability until the underlying issues are resolved.”

In other news, debate about the idea of creating a separate budget for eurozone countries is intensifying with the approach of the European Union summit.

At a private dinner held last week among the European Union ambassadors of several northern European countries, including Britain, Denmark, the Netherlands and Finland, there was surprise among the members to find a fair degree of consensus on the aforementioned proposal.

“I wouldn’t say that there was strong support for it, but there was certainly a feeling that this is an idea that should be explored in more detail,” said one diplomat that was present during the meeting.

The single budget proposal was first sketched out by Herman Van Rompuy, the president of the European Council. The proposal for the budget was first seen in a paper that circulated in September as part of an effort to stimulate debate about how Europe’s monetary union should be improved. In the paper, Van Rompuy said that a fully functioning grouping of all 17 countries that use the euro could involve the creation of a central budget and single treasury office.

The role of this central treasury office may be something along the lines of maintaining control of the debt shared by the 17 countries. There is still no clear definition of what a single, central budget would entail, but Germany strongly supports the idea, and France is on board too in terms of eurozone decision making, which means it has some serious power behind it.