Research & Commentary

ECB Doubles Down on Defeating A Deflation It Doesn’t See

The European Central Bank sees no risk of falling prices. But the threat of real deflation looms large.

In March 2017, European Central Bank (ECB) President Mario Draghi declared that “the risks of deflation have largely disappeared.” This month, in a Bucharest speech, ECB Chief Economist Peter Praet declared that “…uncertainty about the inflation outlook has been declining significantly and the risk of deflation has vanished.” Vanished! Such confidence is, of itself, a warning that it hasn’t. Their definition of deflation in this respect is falling consumer prices. As the chart below shows, the Eurozone Consumer Price Index (CPI) has experienced three occasions of declining on an annual basis – in 2009, 2015 and 2016. The latest reading shows that the Eurozone CPI is rising at an annual pace of 1.73%, still lower than the previous two peaks. Nevertheless, the ECB seem in no doubt that consumer prices will not be falling again anytime soon.

But let’s take a look at the proper definition of inflation and deflation – the increase or decrease in money and credit in an economy. The next chart shows the annualized change in EWI’s Money and Credit Index (MACI) for Germany. MACI for Germany consists of German central and state government debt, household debt and M3 money supply. Since the Quantitative-Easing-related surge in 2010, the year-on-year rate of change in MACI has been declining; the latest reading is just 0.43%. The pace of credit and money expansion in Germany, at least, has been slowing (disinflation) and the threat of contraction (deflation) is clear and present. Of course, our Elliott wave analysis currently suggests that Eurozone stock markets are at risk of declining and that will very probably mean debt deflation in the bond markets. Consumer prices can still increase when money and credit is contracting but it is relatively rare. We’ll let the ECB bask in its perceived glory of defeating falling consumer prices and keep our focus firmly on the real economic engine – money and credit.

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