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April 3 (The following statement was released by the rating agency)
Recent comments suggesting that quantitative easing (QE) is becoming a less contentious policy option in the eurozone reduces the risk of deflation in the region, Fitch Ratings says.
European Central Bank Governing Council member and Bundesbank president Jens Weidmann said last week that the ECB might consider buying "private or public assets" and that "we are currently discussing the effectiveness of these measures" as well as possible costs and side-effects. Opposition from the Bundesbank has long been seen as a potential obstacle to the ECB following the lead of other global central banks and embarking on QE.
There is no guarantee that discussing QE will result in the launch of a programme. Nor is there a guarantee that QE would be sufficient in itself to ward off the spectre of deflation. Nevertheless, considering QE indicates that the ECB is prepared to add to its unconventional policy tools to tackle the risk of deflation, if necessary.
We do not currently predict prolonged, self-sustaining deflation in any of the world's major advanced economies (MAEs), including the eurozone, where we think economic recovery, coupled with private deleveraging and improved private funding conditions, will see the region avoid long-lasting deflation, such as that experienced by Japan from the 1990s. However, the success of "Abenomics" in breaking Japan out of deflation is still far from assured, illustrating how pernicious deflation can become once entrenched.
We do think that the risk of deflation is higher in the eurozone than in other MAEs over the next two years. This is partly because eurozone inflation is already low and falling. Eurostat said Monday that seasonally-adjusted eurozone consumer price inflation dropped to 0.5% in March from 0.7% in February and well below the ECB's target of close to, but not at, 2%. This gives little buffer against any further negative shocks.
We also see deflation as a greater risk in the eurozone because of the more limited policy response readily available to the ECB, which is near the zero lower bound for nominal interest rates. It is unlikely that experimenting with mildly negative deposit rates would be transmitted into a meaningful stimulus to the real economy (see Global Economic Outlook published on 14 March).
It is far from clear what form any eventual QE programme would take, and it would still face potential political and legal challenges given the prohibition on monetary financing under the Treaty of the European Union. The pool of private sector bonds that could be bought is smaller than in, say, the US. And with core sovereign yields low and spreads between core and periphery yields compressing, the impact of government bond purchases may be limited.
However, if Weidmann's comments do signal a more open stance to QE, it would reinforce our view that eurozone authorities and policy-makers are alive to the continuing risks to the bloc's long-term recovery and adjustment. These include deflation or an extended period of low inflation across the eurozone, which would put pressure on debt dynamics in highly indebted countries, and would also make the continuing competitiveness adjustment by the periphery relative to the core more difficult.