Christine Lagarde, President of the European Central Bank, speaks to the media following a meeting of the ECB governing board at ECB headquarters on March 12, 2020 in Frankfurt, Germany.
A flash reading Tuesday showed that annual headline inflation — which is closely monitored by the ECB — is expected to come in at -0.2% in August, down from 0.4% in July.
In addition, core inflation — which strips off volatile items such as energy prices and therefore gives a more stable picture of prices — sank to 0.4% year on year in August from 1.2% in July. This was the lowest reading since records started in 2001.
“It’s a shocker,” Frederik Ducrozet, strategist at Pictet Wealth Management, said in reaction to the latest numbers.
The ECB had already told markets in June that it was expecting low inflation figures for the next two years. It estimated then, under its worst-case scenario, that headline inflation would slowly rise from 0.2% in 2020 to 0.9% in 2022.
These forecasts come in well below the ECB’s mandate of keeping “inflation rates below, but close to, 2% over the medium term.”
After Tuesday’s reading, analysts now expect the ECB to lower its forecasts and, more broadly, adjust its stimulus policy in a few months.
“Today’s inflation data seriously question the ECB’s baseline inflation scenario and the inflation forecasts from June,” Christopher Dembik, head of macro analysis at Saxo Bank, said in a note.
“It puts pressure on the ECB ahead of the September 10 meeting and will force the Governing Council to adopt a dovish stance to address investors’ concerns about lower-for-longer inflation.”
The central bank is due to update its inflation estimates in September.
Florian Hense, euro zone economist at Berenberg, said that, “given the recent volatility in the data, the ECB may choose to look through the considerable short-term variations” when it meets next week.
The bank can also stress that it has “already delivered an unprecedented stimulus amid the Covid-19 pandemic and that part of its policies work with a lag. Still, that may not be enough,” he added.
In the wake of the pandemic, the ECB started a more flexible program of government bond purchases, and expanded its overall size before the summer to 1.35 trillion euros ($1.62 trillion). It is set to be in place at least until June 2021.
Now, however, analysts expect more stimulus before the end of the year.
“If inflation remains very low, the ECB may decide in December to extend its crisis-response asset purchase programme,” Hense said in a note.
While Ducrozet added: “The ECB will ultimately increase the PEPP (Pandemic Emergency Purchase Program) envelope again, most likely by 500 billion euros ($ 599 billion) in December, hoping that this could be their last move as fiscal policy takes over to support the recovery.”