Draghi gets taste of 2015 inflation as ECB readies QE

European Central Bank President Mario Draghi will this week get his first taste of one of the dominant challenges for the euro-area economy for 2015. Consumer prices probably recorded the first annual decline in more than five years in December amid a slide in the cost of oil, aggravating concern at the European Central Bank that subdued inflation will become entrenched. With Italy in recession, French momentum lackluster and Germany struggling to leave a weak patch behind, policy makers are haggling over stimulus as governments drag their feet on economic reforms.

Inflation data on Jan. 7 may tip the scales in favor of large-scale sovereign-bond purchases when the ECB president leads a meeting of the Governing Council later this month. He said last week that the risk of deflation "cannot be entirely excluded," while others led by Bundesbank President Jens Weidmann favor holding off to allow previous measures to take effect.

"Downside surprises on inflation are far from over," said Jacques Cailloux, chief European economist at Nomura International Plc in London. "That's probably going to be the very important theme for the year."

Consumer prices dropped 0.1 percent in December from a year earlier, according to the median forecast in a Bloomberg News survey. That would be the first decline since October 2009, when the economy was struggling to recover from a slump after the financial crisis. Core inflation probably held at 0.7 percent.

The Frankfurt-based ECB aims to keep inflation just below 2 percent, and Chief Economist Peter Praet said in an interview with Germany's Boersen-Zeitung last week that consumer prices may decline "during a substantial part of 2015." Policy makers' analysis is complicated by the prospect of renewed political turmoil in Greece, which holds snap elections on Jan. 25, three days after the Governing Council meeting. The vote could deal power to opposition group Syriza, which wants to abandon the austerity measures and economic overhaul linked to the country's bailout agreements.

The euro weakened to its lowest since 2006 today amid concern Greece will exit the currency union. It had depreciated 0.6 percent to $1.1936 at 11:25 a.m. Frankfurt time. "I don't think a Greek crisis would be completely isolated," Alberto Gallo, head of European macro credit research at London-based Royal Bank of Scotland Group Plc told Bloomberg Television's Jonathan Ferro today. "This is a make or break year for Europe."

Uncertainty about Greece's future threatens to weigh on a euro-area economy already struggling to pick up speed, leaving companies with little pricing power. The ECB forecasts inflation of 0.7 percent this year and 1.3 percent in 2016, with economic growth of 1 percent and 1.5 percent. "The danger of a deflationary spiral, I don't see that," said Holger Schmieding, chief economist at Berenberg Bank in London. "But regardless of this danger, with such a slow economy, with a very, very low core inflation rate, it's simply right for a central bank to add to stimulus."

Draghi said in an interview with German newspaper Handelsblatt published last week that while deflation risks are "limited," policy makers "have to act against such risk." Asked how much the ECB might spend on government bonds, he answered that it's "difficult to say."

ECB Executive Board member Benoit Coeure has said there's broad consensus among officials for more action. Staff are preparing a quantitative-easing package for discussion at the Jan. 22 meeting, and more than 90 percent of economists in Bloomberg's monthly survey in December predicted QE will start this year.