Why low inflation in Europe clashes with US monetary policy



Earlier this year, given the growing risk of deflation in Europe, the European Central Bank (or ECB) further eased monetary policy. Included in its actions was a move to push short-term deposit rates into negative territory, the first time a major central bank has attempted this. The ECB’s combination of rate cuts and other measures, including a commitment to expand its arsenal if necessary, add up to a significant easing of credit conditions. Elsewhere, we believe the Bank of Japan (or BoJ) is likely to continue its own very aggressive asset purchase program through 2016.

Aside from Japan, inflation in major economies continues to drop 2014-08-26

Market Realist – As the graph above shows, inflation rates in the UK (EWU) and Germany (EWG) are stable. This is conducive to the low interest rate environment.

Japan, in particular, saw low inflation for two decades before picking up in Q1 of 2013. Still, its inflation remains very low.

Generally, central banks increase rates when inflation is high and there’s a need to rein it in. With inflation rates increasing steadily in the U.S. (SPY)(IVV), the Fed might soon pull back on its bond buying program and increase rates while other central banks are slashing rates.

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