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Disappearing Eurozone Inflation Set to Heighten ECB Concerns

European Central Bank Executive Board member Benoit Coeure (L), Greece's Prime Minister Antonis Samaras (2nd L) and European Central Bank Mission Chief for Greece Klaus Masuch (R) talk after a meeting at the Prime minister's office in Athens, August 28, 2014.
European Central Bank Executive Board member Benoit Coeure (L), Greece's Prime Minister Antonis Samaras (2nd L) and European Central Bank Mission Chief for Greece Klaus Masuch (R) talk after a meeting at the Prime minister's office in Athens, August 28, 2014.
Reuters

Eurozone inflation dropped as expected to a fresh five-year low in August, data showed on Friday, something likely to concern the European Central Bank but not force it into immediate policy intervention.

Consumer prices in the 18 countries using the euro rose by just 0.3 percent year-on-year in August, the smallest increase since October 2009, the European Union's statistics office Eurostat reported.

Inflation, which dropped unexpectedly to 0.4 percent in July, has been locked in what ECB President Mario Draghi called a 'danger zone' of below 1 percent since October last year.

Vanishing inflation poses problems for the ECB as it tries to respond to the bloc's stalled recovery, which is facing additional struggles because of economic sanctions imposed against Russia in July over its involvement in the deepening conflict in Ukraine.

“The very low eurozone inflation reading for August reinforces pressure on the ECB to consider further monetary stimulus on top of what is already in the pipeline,” said Martin van Vliet, senior eurozone economist at ING.

Any immediate action coming at the ECB's Sept. 4 policy meeting is not considered likely, though also not impossible, according to ECB sources talking to Reuters earlier this week. The bank is likely to wait.

Investors and markets, however, will seek more insight from Draghi about what can and will be done by the ECB and European governments to push through reforms and revive growth.

A cocktail of jobless recovery, sluggish growth and low inflation is a major worry for the eurozone and the ECB has urged governments to speed up implementation of structural reforms, vital for Europe's economy to heal.

Some countries are opposed to too much loose monetary policy, however, and there are a number of reform laggards in the currency bloc.

“He is walking a tightrope between conservative European institutions and the markets desire for more stimulus,” said Guy Nicholls at Aberdeen Asset Management.

“But as every month passes we get closer to the dread of deflation and Draghi looks more and more like Nero fiddling while Rome burns,” he added.

The euro rose to the day's high of $1.3195 as investors trimmed bets against the currency after the data and German Bund futures fell.

The drop in August inflation was led by a 2.0 percent decline in the highly volatile prices of energy and a prices of food, alcohol and tobacco falling by 0.3 percent for a second month in a row in August.

In June, the ECB cut interest rates to record lows, started charging banks to keep their funds overnight and launched a new long-term loan program, which will start in September and aims to give banks an incentive to lend more to the real economy.

Since then, the ECB has been in a wait-and-see mode, wanting to see the impact of its new liquidity injection first before considering further stimulus measures, though Draghi has stressed repeatedly the ECB stands ready to do more if needed.

The ECB targets an inflation rate at below-but-close to 2 percent, a level not seen since the first quarter of 2013.

In a separate data release Eurostat said that unemployment in the eurozone was, as expected unchanged at 11.5 percent for a second months in a row in July, leaving 18.4 million people without jobs in the 9.6 trillion euro economy.

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