Decline in commodity prices sees low inflation put squeeze on ECB

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A persistent supply glut has seen oil prices fall sharply in November, with prices in the US threatening to drop below $40 a barrel at one stage writes Oliver Mangan,Chief Economist atAIB.

Oil prices could well fall further in the coming months, with Iranian exports set to hit the world market following the ending of sanctions.

A mild winter this year would add to the downward pressure on prices given the extent of over-supply. Some commentators see oil falling to $20 a barrel unless Opec moves to rein in production. Up to now, oil producers have been reluctant to cut back on output despite the persistent oversupply and glut on the world market.

Meanwhile, other bellwether commodities such as copper, zinc, iron ore and coal have seen their prices fall recently to their lowest levels since the financial crisis six years ago, reflecting weak demand in industrial economies, including China. The Baltic Index, which tracks rates for ships carrying dry bulk commodities, has fallen sharply to its lowest level in 30 years.

The further marked decline in commodity prices means that inflation will remain very low for an even longer period of time. Inflation has been at zero or negative for all of this year in the major world economies, driven down by the collapse in commodity prices.

The expectation had been that inflation would start to rise towards the end of 2015. However, the fresh falls in commodity prices mean that the period of very low inflation will extend well into 2016.

The persistence of very low inflation is forcing the ECB to consider loosening policy even further. Meanwhile, it will limit rate increases in the US where policy is about to be tightened. It is also encouraging other central banks such as the Bank of England to delay even further any plans to raise rates.

This is a continuation of a pattern evident over the course of this year. More than half the world economy has seen further monetary loosening in 2015 as central banks responded to falling inflation by moving to an even more accommodative policy stance. Meanwhile, central banks that were contemplating raising rates, instead kept policy on hold.

Central banks, though, are failing to revive inflation with their ultra-loose monetary policies. Core inflation rates, which exclude food and energy, are running at just around 1% in most economies.

A combination of weak growth and low wage increases, as well as high unemployment in many countries, is dampening underlying inflationary pressures. Six years after the end of the 2008-09 ‘Great Recession’ and financial crisis, the world economy is still enduring just a moderate and very uneven recovery.

Japan has slipped back into recession again this year, the eurozone is experiencing only a moderate pick-up in activity, while the US and UK economies have seen solid enough growth. Major divergences are also evident in labour markets in advanced economies.

There is close to full employment in the US, Japan, Germany and the UK, where unemployment rates are around 5%, or below. By contrast, other economies, including France, Italy and Spain have high, have double-digit unemployment rates. These varying economic conditions are posing challenges for central banks.

Thus, while the Fed is about to start raising interest rates, it has indicated that monetary tightening will be very slow paced. And the BoE has indicated that rate hikes are not on its agenda any time soon.

By contrast, the ECB is under pressure to ease policy even further. Its very loose monetary stance has not boosted inflation, while eurozone growth is still quite subdued. It has been looking at an array of policy options to try and revive inflation and growth.

The ECB is now testing the outer limits of monetary policy. Another round of loosening measures looks set to be unveiled on Thursday, following a meeting of its Governing Council. The euro could well take a further hit if these measures prove aggressive, taking the ECB even deeper into unchartered waters.

Source: Irish Examiner December 1st 2015