• Last week the European Central Bank announced a series of measures to boost the region's economy and head off the risk of deflation. Most eye-catching was a reduction in the interest rate, to minus 0.1%, which the ECB offers banks on their deposits.
  • A negative interest rate is akin to a levy on deposits at the Central Bank. By penalising such deposits the ECB hopes it will encourage banks to lend more to companies and consumers. As well as the penalty of negative interest rates the ECB is offering an incentive, in the form of ultra-cheap ECB funding, for banks that lend to the private sector.
  • This all amounts to a significant easing of euro area monetary policy. Markets were left in no doubt that the ECB may well go further. The ECB President, Mario Draghi, said that ECB rates will remain at current, very low levels, "for an extended period of time" and said the Bank is prepared to do more, if necessary, to boost euro area growth.
  • Mr Draghi first deployed the ECB "bazooka" in July 2012 to still fears of a breakup of the euro area. He said the Bank was prepared to do whatever was needed to save the euro area and promised that the ECB would buy the bonds of at-risk governments without limit. The announcement was a turning point in the euro area crisis, setting off a rally in peripheral euro area government bonds and all but ending speculation about the imminent breakup of the Single Currency.
  • Last week's announcement from the ECB was an attempt to repeat a similar trick, albeit against a different target. The fear now is of deflation.
  • Euro area inflation has fallen faster than expected in the last year and, in May, hit 0.5%, far below the ECB's target of below, but close to, 2.0%. The fear is that the euro area could slip into Japanese-style deflation, with falling prices and economic stagnation.
  • Falling prices encourage consumers and corporates to delay spending in order to benefit from lower prices in the future. Deflation drags down asset prices, eroding household wealth and confidence. But debts remain fixed and the burden of servicing debt rises. Deflation also makes it harder for countries, such as Greece and Italy, to regain competitiveness. Lower inflation in core euro area countries, such as Germany, requires peripheral economies to run even lower inflation in order to restore competitiveness.
  • The euro area is easing monetary policy at precisely the time that the UK and the US are debating how and when to tighten policy. Euro area interest rates are likely to be on hold for a long time, while UK rates could rise before the end of this year. The implication is that the dollar and sterling may well make further gains against the euro.
  • The risk of deflation in the euro area is real, but we would not want to overdo the pessimism. Euro area monetary policy is loose and getting looser. This has fed through to financial markets, pushing yields on government bonds down to record lows and boosting stock markets. In the last year, shares in Spanish banks have risen by more than 60%.
  • Business and consumer confidence is on the rise across the euro area. And while bank lending is continuing to contract, the worst is probably past. The ECB's own bank lending survey shows an uptrend in corporate and household demand for credit. Banks expect this demand to increase. Nor is falling inflation unalloyed bad news. Lower prices boost consumer spending power.
  • The ECB is determined to avoid a descent into deflation. To do so, it is likely to keep euro area interest rates at ultra-low levels and could go further and start a full scale programme of Quantitative Easing. Our hunch is that loose monetary policy will work its magic and that the euro area economy will see a gradual, if patchy, pickup in activity over the next year.

MARKETS & NEWS

UK's FTSE 100 ended the week down 0.1%.

Here are some recent news stories that caught our eye as reflecting key economic themes:

KEY THEMES

  • The European Central Bank become the first major central bank to cut its deposit rate below zero, meaning banks will pay a charge to hold money in Frankfurt
  • China is now the largest buyer of industrial robots according to the International Federation of Robotics, with rising wage costs forcing manufacturers to turn to technology
  • The vice-president of the European Commission warned robot makers that they must do more to reassure the public over concerns about the automation of jobs
  • The amount British households have deposited in cash ISAs fell in April at the fastest monthly rate since the accounts were introduced in 1999
  • Ratings agency S&P was censured by the EU securities watchdog for wrongly announcing in 2011 that France's credit rating had been downgraded
  • Italy, Europe's second most indebted country, sold €7.5bn of government debt at the lowest level of interest since the eurozone was established in 1999
  • British supercar manufacturer McLaren made a profit for the first time last year, benefitting from strong demand in Asia and the success of its £1m P1 model
  • The Institute for Fiscal Studies (IFS) forecast that an independent Scotland would face a £8.6bn budget deficit in its first year of independence
  • A survey of UK adults by the Office for National Statistics (ONS) found that "as household income increases, life satisfaction and happiness rise, while anxiety falls"
  • The world's first solid gold credit card was launched on the Isle of Man, allowing depositors to access cash against the value of their gold deposits
  • Germany is to lift its ban on fracking, responding to business demands to reduce its dependency on Russian energy and boost competitiveness with US manufacturers
  • The Financial Times (FT) reports that the US plans to impose additional import duties of up to 35.2% on Chinese-made solar panels
  • French President François Hollande unveiled plans to cut the number of French regions from 22 to 14, in order to streamline the country's bureaucracy
  • Vodafone is to move its product innovation and development team from Silicon Valley to London, closer to customers in Europe, Africa and India
  • Mobile subscriptions will exceed the world's population next year according to Ericsson, with the strongest growth to be seen in connecting machines and appliances to the internet
  • The founder of Chinese ecommerce group Alibaba agreed to buy 50% of Guangzhou's Evergrande football club, reportedly to bolster Alibaba's appeal ahead of its planned flotation
  • François Hollande was forced to eat two dinners in one evening in order to keep his state guests, Barack Obama and Vladimir Putin, from having to eat together – double-talk

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.