1. Economic Commentary
QNB Economics
economics@qnb.com
March 8, 2014
The Risk of Deflation is Likely to Keep Short-Term
Interest Rates Low
In the Eurozone and the US, inflation
remains dangerously low and well below
the 2% central bank targets. Inflation is
not expected to pick up in the short term
as weak global demand holds back global
energy and food prices. With weak
growth expected in Europe and recent
disappointing economic data in the US,
the risk of deflation remains high. As
such, European and US central banks are
likely to keep monetary policy loose for
an extended period. Therefore, QNB
Group expects short-term interest rates
in the Eurozone and the US to stay low
for longer than prevailing market
expectations.
CPI Inflation (Jan-2010 to Feb-2014)
(%, year–on–year)
4.0
3.5
3.0
2.5
2.0
1.5
US
1.2*
1.0
0.8
Eurozone
0.5
0.0
Jan10
Jul10
Jan11
Jul11
Jan12
Jul12
Jan13
Jul13
Feb14
Sources: Bloomberg and QNB Group analysis
*Consensus forecast
In the Eurozone, annual inflation has
stabilized at 0.8% in recent months.
Core inflation (excluding energy and
food) is low at 1.0%, energy price
inflation is negative and food inflation is
flat. The European Central Bank (ECB)
expects inflation to be 1.3% over the
next year. This alone gives the ECB
reason to take policy action, but there
are a number of additional factors that
add further incentive. The ECB expects
real GDP growth to be only 1.1% in the
Eurozone
over
the
next
year.
Unemployment is high, stuck at around
12%,
on
average,
with
youth
unemployment above 50% in some
periphery countries. The Euro has
strengthened 6.7% over the last year
against a weighted basket of currencies.
Overall, all these indicators suggest a
strong risk of deflation, which are likely
to prompt the ECB to loosen monetary
policy, possibly by a small cut in interest
rates, quantitative easing or other
measures to increase liquidity.
In the US, annual inflation picked up
from 1.0% in October 2013 to 1.6% in
January 2014. However, US inflation is
expected to slow sharply to 1.2% in
February as the impact of a sharp rise in
gasoline prices falls out of the annual
number and as core inflation continues
to slow. The low inflation outlook and
some indications that the US economic
recovery may be weakening, raises the
potential for another round of loosening
of monetary policy by delaying the
tapering of Quantitative Easing (QE).
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2. Economic Commentary
The Federal Reserve (Fed) has shown
firm commitment to QE tapering during
early 2014, despite a soft patch in
economic data, which has widely been
put down to bad weather. However, this
resolve may be easing as recent
comments from the Fed Chair, Janet
Yellen, have indicated that QE tapering
could be adjusted if the US economy
weakens. Upcoming economic data
releases in March and April should give a
clearer picture on how much of the
recent weak economic data can be put
down to bad weather. We do not expect
the picture to be clear enough for the
Fed to postpone QE tapering at its next
meeting on March 19, but by the time the
Fed meets on April 30, there is some risk
that the economic outlook could have
deteriorated enough to warrant a
slowdown in the pace of QE tapering
(the first reading of GDP growth in Q1
2014 is also released on April 30) to
offset the risk of deflation.
The potential for falling inflation in the
Eurozone and US will make central
banks wary of falling into a deflationary
trap. According to economic theory,
deflation fuels expectations that prices
will continue to fall, encouraging delays
to purchases, thus holding back growth
(Japan’s experience in the last two
decades is a good example). It also
increases the real value of outstanding
domestic debt, thus making it more
QNB Economics
economics@qnb.com
March 8, 2014
difficult
for
borrowers
to
make
repayments. Deflation also tends to lead
to
a
stronger
exchange
rate,
undermining
competitiveness
and
growth. On the other hand, a moderately
inflationary
environment
reinforces
expectations that prices will continue to
rise
and
encourages
spending,
borrowing,
growth
and
a
more
competitive exchange rate. For these
reasons, central banks tend to use
monetary policy to target moderate
annual inflation of around 2%, thus
avoiding the perils of a deflationary trap.
Looking ahead, the risk of deflation and
weak economies in the US and Eurozone,
present a strong case for the Fed and
ECB to loosen or refrain from tightening
monetary policy. This implies that any
increase in short-term interest rates in
the Eurozone or in the US is still some
way off. Qatar’s policy rates tend to
track rates in the US owing to the pegged
exchange rate. Therefore, interest rates
are also likely to remain low in Qatar. A
pause in tightening monetary policy in
the US would have the added benefit of
bringing greater stability to global
financial markets. The implementation
of QE tapering has led to capital
outflows from a number of emerging
markets, weakening their currencies and
driving down asset prices. Delayed QE
tapering could help bring greater
stability.
Contacts
Joannes Mongardini
Head of Economics
Tel. (+974) 4453-4412
joannes.mongardini@qnb.co
m.qa
Rory Fyfe
Senior Economist
Tel. (+974) 4453-4643
rory.fyfe@qnb.com.qa
Ehsan Khoman
Economist
Tel. (+974) 4453-4423
ehsan.khoman@qnb.com.qa
Hamda Al-Thani
Economist
Tel. (+974) 4453-4646
hamda.althani@qnb.com.qa
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3. Economic Commentary
QNB Economics
economics@qnb.com
March 8, 2014
Disclaimer and Copyright Notice: QNB Group accepts no liability whatsoever for any direct or indirect losses arising
from use of this report. Where an opinion is expressed, unless otherwise provided, it is that of the analyst or author only.
Any investment decision should depend on the individual circumstances of the investor and be based on specifically
engaged investment advice. The report is distributed on a complimentary basis. It may not be reproduced in whole or in
part without permission from QNB Group.
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