Disinflation, Again

In comments at the beginning of this week about the battle being waged by central bankers in Western economies and Japan to avoid the onset of deflation, this writer noted that the European monetary authorities particularly may have to loosen policy even further. Statistics for October that had just been released indicated a clear disinflationary trend, with prices rising a mere 0.7% in the eurozone as a whole, the lowest rate in over four years, and easily one of the lowest in the entire post-war period.

Today, the European Central Bank (ECB) did just that - it dropped its key re-finance rate, from 0.5% to 0.25%. Further, ECB head Mario Draghi indulged in a bit of "forward guidance", stating that he expects rates to be very low, or lower, for a long time. The timing of the move has taken markets by surprise, although there had been some talk of a cut later this year. But this further easing of monetary policy should be anything but surprising, given that the economies of southern Europe (Portugal, Spain, Italy, Greece and Cyprus) remain mired in recession and unemployment (quick primer: Italy's finance minister, Fabrizio Saccomanni, last week revised downward his estimate of economic performance to -1.8% for 2013, indicating that the country's longest recession since the second world war was not bottoming out). And because these countries are part of the eurozone currency bloc, individual currency devaluation - a traditional tool for stimulating growth - has not been available to their respective national authorities.

Ultra-low and declining rates of inflation (disinflation) - and the very real threat of this morphing into deflation, which has already started in Greece, which Japan has been fighting for 15 years, and which the world faced in the 1930's - are clearly the principal backdrop for today's ECB action. But the move has had an additional, fully-intended effect today - that of lowering, swiftly and substantially, the value of the euro against other major world currencies. This lowers the price, and hence boosts the competitiveness, of exports from all European countries (even, of course, those from Germany, which hardly need any additional boost).

There is just one risk to this devaluation strategy - that other countries enter the game. (Watch Japan in particular.) Competitive devaluation of the world's currencies, and deflation, are helpful to no one.