Draghi deflation relief means little with Greece unsolved

With a solution to the Greek crisis still out of reach, Mario Draghi can count on at least one piece of good news this week: euro-area consumer prices are rising again.

Economists in a Bloomberg survey forecast that the inflation rate rose to 0.2 percent in May from zero in April. The report, due on Tuesday, would follow improving data from Spain and Italy and mark the first price increase in six months.

While the European Central Bank president can take comfort from the fading deflation risk, he and his fellow policy makers will be distracted by a looming Greek loan repayment that could make or break months of negotiations aimed at funding the country and preventing a splintering of the currency bloc. As the economy stutters through its recovery, concerns about the debt crisis are putting the reins on consumer and business sentiment across the region.

“There’s not a huge uncertainty about the economic outlook, there’s more uncertainty about Greece,” said Holger Sandte, chief European analyst at Nordea Markets in Copenhagen. The return of inflation is “good news for the ECB,” he said. “In the months ahead, while we might get a setback, the tendency is upward.”

The euro weakened on Monday as Greece struggled to seal an accord with the International Monetary Fund, to which the nation owes the first of four payments this month on June 5. The euro traded at $1.0938 at 9:14 a.m. Frankfurt time, down 0.4 percent from the previous close.

ECB Gathering

The improving inflation backdrop partly reflects a rebound in oil prices since falling to a six-year low in January. ECB policy makers may also see it as a sign their 1.1 trillion-euro ($1.2 trillion) stimulus is working.

Draghi said last month that the unconventional actions “have proven so far to be potent, more so than many observers anticipated.” Governing Council member Patrick Honohan said that price inflation is “getting back up.”

ECB policy makers will gather in Frankfurt this week for their six-weekly meeting, with Greece set to dominate the agenda. They will assess any new emergency liquidity request and whether to restrict conditions for the funds that Greek banks need to stay afloat as the government tries to prevent a default.

Talks between Greece and creditors to resolve the crisis missed another deadline at the weekend. The country must make four payments totaling almost 1.6 billion euros to the IMF this month, with the first due Friday.

Stuttering Recovery

“There is no automatic — and I underline the word — connection between a default of the Greek government and the insolvency of Greek banks,” ECB Vice President Vitor Constancio said on Thursday. Greek banks “can sustain the impact of a potential impairment in Greek public debt and still remain with capital ratios above the minimum.”

The central bank will also publish new forecasts on Wednesday. While they will probably record the better outlook for inflation, Draghi is likely to reaffirm that it is dependent on the full implementation of the quantitative-easing program.

Other releases this week will paint a picture of a recovery that’s progressing, albeit on an unsure footing that could easily be disrupted by a blow-up in the Greek crisis.

Markit will publish the final readings for its May Purchasing Managers’ Indexes on Monday and Wednesday. The provisional composite gauge of manufacturing and services slipped to a three-month low of 53.4 in May from 53.9.

Unemployment Rate

German inflation data on Monday — forecast to show the biggest price increase in seven months in May — will preview the euro-wide figures on Tuesday. In Italy, the inflation rate came in at 0.2 percent, higher than economists had anticipated.

Eurostat, the EU’s statistics office in Luxembourg, will release its second GDP estimate for the three months through March on Friday, with detail on consumer spending and exports. Two days earlier, it will publish data on unemployment, which is forecast to show the jobless rate at 11.2 percent in April.

That headline figure hides even worse numbers, with average euro-zone youth unemployment almost twice as high. In Spain and Greece, the jobless rates are above 20 percent.

“If you look at the long term structural weaknesses, particularly in the labor market, we struggle to see this inflationary momentum building up in a meaningful way,” said Timo Del Carpio, a London-based economist at Royal Bank of Canada. “It doesn’t in any way suggest the ECB should be content to sit on the sidelines.”