Euro area limping toward deflation fuels QE calls as ECB meets

The euro area is edging closer to the moment that deflation risks become reality.

Companies cut selling prices by the most since 2010 as they attempted to boost sales in the face of a flagging economy and slowing new orders, Markit Economics said Wednesday. This in turn is squeezing profit margins and reducing resources for hiring and investing, damping chances of an economic rebound, the London-based company said.

The European Central Bank is pumping money into the banking system to fuel inflation that hasn’t met policy makers’ goal since early last year. With a gauge of manufacturing and services activity pointing to sluggish growth at best, it is under pressure to add to long-term loans and already announced asset-purchase plans to prevent a spiral of price declines in the 18-nation currency bloc.

“This month’s data make for grim reading, painting a picture of an economy that is limping along and more likely to take a turn for the worse than spring back into life,” said Chris Williamson, Markit’s chief economist. “The combined threat of economic stagnation and growing deflationary risks will add to pressure on the ECB to do more to stimulate demand in the euro area, strengthening calls for full-scale quantitative easing.”

A Purchasing Managers’ Index for both manufacturing and services rose to 52.1 in October from 52 in September, below an Oct. 23 estimate of 52.2. A measure for services slipped to 52.3 from 52.4. A reading of 50 divides expansion from contraction.

Deteriorating outlook

While Markit said the data are in line with gross domestic product expanding 0.2 percent in the fourth quarter, new orders slowed to the weakest level in 15 months and employment declined for the first time in almost a year. That “suggests that the pace of growth may deteriorate in coming months,” said Williamson.

Indicators for Germany, Spain and Ireland all pointed to solid growth last month, with Europe’s largest economy headed for a 0.4 percent expansion this quarter. That contrasts with France, where the gauge signaled contraction for a sixth month, and Italy, where the PMI points to economic stagnation.

The European Commission cut its GDP forecasts for the euro area Tuesday and said inflation (ECCPEST) next year will be even weaker than the ECB predicts. The central bank, whose projections are for price growth of 1.1 percent in 2015, will keep interest rates unchanged Thursday, according to all economists in a Bloomberg News survey.

Base effect

Inflation accelerated to 0.4 percent in October from a five-year low, offering some reprieve to policy makers waiting for stimulus to reach the economy. Still, the pick-up was mostly due to a sharp drop in price gains last year, and core inflation slowed to 0.7 percent. Producer prices extended their annual decline for a 14th month in September.

“The eurozone still faces worryingly a significant deflation risk and is struggling markedly for growth,” said Howard Archer, chief European economist at IHS Global Insight in London. “Unless there is a sustained, clear change in the eurozone’s fortunes, the ECB could yet ultimately have to go down the QE road.” [Bloomberg]

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