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By HaleStewart November 8, 2013 8:36 am
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Sensing Deflation, ECB Cuts Rates; Euro Dives

Yesterday the ECB cut the overnight rate fo 25 basis points.  The following text from Craghi's statement highlights the banks thinking:

"First, based on our regular economic and monetary analyses, we decided to lower the interest rate on the main refinancing operations of the Eurosystem by 25 basis points to 0.25 percent and the rate on the marginal lending facility by 25 basis points to 0.75 percent. The rate on the deposit facility will remain unchanged at 0.00 percent. These decisions are in line with our forward guidance of July 2013, given the latest indications of further diminishing underlying price pressures in the euro area over the medium term, starting from currently low annual inflation rates of below 1 percent. In keeping with this picture, monetary and, in particular, credit dynamics remain subdued. At the same time, inflation expectations for the euro area over the medium to long term continue to be firmly anchored in line with our aim of maintaining inflation rates below, but close to, 2 percent.

As I've noted before, the EU is facing a potential deflation problem which leads to slower overall economic growth.  Consumers see prices dropping, so they delay purchase of goods in anticipation of price drops.  This slows overall production, as businesses make fewer goods.  The combination of both these effects is to slow the overall economic growth of the region.  This has been Japan's central problem for the past 20 years, which highlights how negative this problem is, how entrenched it can become and difficult it is to remedy.

In addition, note the inflationary expectations are "anchored."  This simply means that consumers as a whole are not expecting any inflationary pressure in the longer term.  This gives the central bank some breathing room, allowing them to take aggressive monetary action to add soe inflation to the system.

Hale Stewart is a former bond broker who has been writing about economics and financial markets since 2006 on the Bonddad Blog.  He is also a tax attorney with a domestic and international practice while also forming and managing captive insurance companies for US companies.   You can follow him on twitter at:@captivelawyer

 

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