Could the Eurozone start what the US is about to stop?

Chart showing falling Eurozone inflation from nearly 3% in January 2012 to less than 0.5% in July 2014

The European Central Bank (ECB) has an inflation target of “below, but close to, 2% over the medium term.”

As of August 2014, annual inflation across the Eurozone was just 0.3%. Inflation has not been above 1% since September 2013 and, with a few minor blips, has been heading down relentlessly since a 3% peak in November 2011. The decline has been accompanied by next to no economic growth: figures released in August showed that no growth during the second quarter of 2014 in the economies of the three largest Eurozone constituents – Germany (-0.2%), France (0.0%) and Italy (-0.2%). For the Eurozone as a whole, the reading was zero, thanks to growth in Spain and the Netherlands.

There is now concern inside and outside the ECB that the Eurozone could suffer deflation (falling prices) and a miserable economic experience similar to that of Japan with its ‘lost decade(s)’. The ECB cannot cut interest rates any more – they are already negative for banks placing cash with the central bank. Mario Draghi, the ECB President, has now started to hint that the next step could be quantitative easing (QE). This would probably involve the ECB buying Eurozone Government bonds, echoing similar (and much earlier) action from the US Federal Reserve and Bank of England. If it happens, the ECB’s first round of QE could come on the heels of the end of the Fed’s bond-buying program, currently scheduled for October. The Bank of England stopped buying bonds in November 2012, although it still holds £375bn of Government stock.

At this late stage there are doubts about whether QE will work in the Eurozone. Medium term interest rates are already very low and the possibility of QE has pushed yields on 10 year German Government bonds below 1%. Nevertheless, the mere prospect of QE gave an August boost to Eurozone share values.

It will be worth keeping an eye on developments in our European neighbourhood.

The value of your investment can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance. Investing in shares should be regarded as a long-term investment and should fit in with your overall attitude to risk and financial circumstances.