Reflationary forces at work in Europe

Reflationary influences have replaced deflationary forces in the eurozone, according to European Central Bank (ECB) President Mario Draghi. He believes that current inflationary weakness is temporary and that the ECB’s monetary policy is working. Nevertheless, he thinks that a “prudent” level of support from the central bank should remain until inflation becomes “self-sustaining”. His remarks triggered speculation that the ECB might be poised to phase out its quantitative easing measures. In response, the euro surged against the US dollar, bond yields rose sharply, and equity markets fell. Over June as a whole, the Dax Index fell by 2.3% while the CAC 40 Index declined by 3.1%.
Earlier in the month, the central bank made it clear that it intends to retain its quantitative easing measures until it sees “a sustained adjustment in the path of inflation consistent with its inflation aim”. The eurozone’s rate of inflation eased from 1.4% in May to 1.3% in June, and the ECB’s target remains at 2%. Looking ahead, policymakers expect inflation to reach 1.5% this year, and 1.3% next year.
Economic growth in the eurozone grew at its most rapid rate for six years during May, according to IHS Markit, boosted by new business and a strengthening labour market. Activity was particularly strong in Germany and France. The ECB upgraded its predictions for economic growth in the euro area to 1.9% in 2017, and 1.8% in 2018. Mr Draghi sounded generally more sanguine about the outlook for the region, describing the risks to growth as “broadly balanced”, compared with his April assessment in which he defined them as “tilted to the downside”.
As expected, France’s centrist pro-EU President Emmanuel Macron won a clear Parliamentary majority during June. Elsewhere, European finance ministers finally reached an agreement to release the next allocation of Greece’s bailout funds; the deal helped to end a period of uncertainty that has undermined sentiment towards the country. The International Monetary Fund (IMF) called for more discussion on debt relief measures for Greece.
Spanish bank Banco Santander unveiled its takeover of smaller competitor Banco Popular amid mounting concerns that the latter might be close to collapse. Meanwhile, the Italian government announced that it would rescue two banks – Banca Populare di Vincenza and Veneto Banca – that were pronounced by the ECB to be in imminent danger of failure.