City Watch: Charles Sylvester reflects on the threat of deflation within the eurozone

Charles Sylvester of Charles Stanley & Co, Ipswich

Charles Sylvester of Charles Stanley & Co, Ipswich - Credit: Archant

According to its eagerly-anticipated quarterly report, published by the Bank of England last Wednesday, the UK’s economy remains on course to absorb the remaining spare capacity over the next few years.

In spite of much stronger unemployment data, currently at its lowest level since 2009, the bank downplayed growing speculation that it was planning to raise interest rates early next year, or even just before Christmas.

Instead it released data on projected interest rates in its inflation report which heavily implied that there would be no change until the second quarter of 2015.

Across the Channel, European policymakers are increasingly worried that the eurozone is on the brink of deflation; particularly after their consumer price index only rose by 0.7% year on year in April, well below the European Central Bank’s (ECB) official target of 2%.

This is partly due to the rather surprising strength of the euro which has risen by 6% against the US dollar over the past 12 months, and has therefore reduced the price of imports.

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Several governments have apparently been lobbying the ECB to try and curb the euro’s rise and to take more steps to boost the zone’s fragile recovery.

The bank’s president, Mario Draghi, actually hinted that he might have come round to this view and suggested that something might be done after its next meeting in June.

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The two options open to them are either introducing a quantitative easing programme, as has been enthusiastically employed by the US Federal Reserve, the Bank of England and the Bank of Japan, although the Germans would have to be persuaded.

A more radical alternative is to introduce negative interest rates, or charging banks for money left on deposit.

This would encourage banks to lend more money, potentially increasing the supply of credit in the weaker eurozone economies and boosting growth.

: : Charles Sylvester is an investment manager with Charles Stanley & Co in Ipswich.

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