The euro slid to a 4-1/2 year low against the dollar Friday after European Central Bank President Mario Draghi indicated the bank could soon back a government bond-buying program to deal with alarmingly low inflation across the 19-nation eurozone.
The currency’s latest foray toward $1.20 was triggered by a warning from Draghi that the bank is now more likely to fail in its ambition to keep prices stable than it was just six months ago.
“We have to avoid too-high inflation and we have to avoid too-low inflation as well,” Draghi told the German financial daily Handelsblatt. “We are making technical preparations to alter the size, pace and composition of our measures in early 2015.”
For many in the markets, that’s a clear hint from Draghi that the bank stands ready to back a full-blown bond-buying program on the lines of those undertaken by other central banks, such as the U.S. Federal Reserve and the Bank of England.
Many experts think the ECB could make the announcement Jan. 22 at its next monetary policy meeting.
The reaction was mostly evident in the currency markets where the euro came close to falling below the $1.20 mark for the first time since June 2010. That was when Europe was reeling from Greece’s first bailout and mounting speculation that other euro members were in acute financial difficulties.
Having fallen to its new multi-year low of $1.2005, the euro steadied somewhat Friday, trading 0.5% lower on the day at $1.2022.
The euro has been in retreat for months on the back of expectations that the ECB will back a further stimulus as traders anticipate more of the currency in circulation.
Although the ECB has cut interest rates to record lows and backed the purchase of some types of private-sector bonds, it has refrained from following others in buying government bonds — so-called quantitative easing.
While anemic levels of economic growth across the eurozone are a major source of concern for policymakers at the ECB, it is too-low inflation that’s prompting the speculation of further action.
Inflation in what is now the 19-country eurozone — Lithuania adopted the euro on Thursday — stands at 0.3%, far below the ECB’s annual target of keeping general price rises just below 2%.
The worry is that too-low inflation turns into an outright drop in prices. Although that sounds good in principle, deflation can choke the life out of an economy if consumers put off purchases in the hope of future bargains and businesses fail to invest and innovate.
Deflation can prove difficult to reverse, as evidenced by Japan’s economic stagnation over the past two decades.
Proponents of quantitative easing say the policy can help shore up a recovery and support prices by reducing the borrowing costs for businesses, households and governments.
The associated fall in the currency could also help boost growth by making exports cheaper and stoke some upward inflationary pressure by making imports more expensive.
But many in Germany, Europe’s most powerful economy, have voiced concerns about such a program, worried that it would amount to throwing money at profligate states. Germans are concerned that the country’s taxpayers will end up being burdened with the debts of countries such as Greece, Italy and Portugal.
Success is not guaranteed, as evidenced by Japan’s return to recession even though the country’s central bank is enacting its own bond purchase program.
“The comments suggest the ECB will soon adopt sovereign debt [quantitative easing] which may come as soon as their next meeting,” said Lee Hardman, a currency analyst at Bank of Tokyo-Mitsubishi UFJ.