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Spanish CPI shock flags deflation risks for eurozone

The euro slid to a three-week low and government bond yields across the eurozone fell on Friday as a surprise fall in Spanish inflation bolstered investors’ bets the European Central Bank will ease policy next week to ward off the threat of a sustained bout of deflation.

Spanish and Italian borrowing costs fell to their lowest in eight years, while stock markets drew support from the renewed potential for looser ECB policy and reports Beijing could fast track infrastructure spending to boost the Chinese economy.

The 0.2 per cent annual rate decline in Spanish consumer prices this month was larger than expected and the weakest figure since October 2009.

The Spanish numbers put preliminary German inflation data for March later in the day under even greater scrutiny for signs that the threat of deflation is spreading from peripheral euro zone economies like Spain to the bloc’s powerful core.

“This is an ECB expectations-driven story,” said Ralf Umlauf, an analyst at Helaba Landesbank Hessen-Thueringen. “The market is definitely positioning for next week’s meeting. Market players are expecting some action - any kind of action.”

The euro hit a three-week low of $1.3704, falling further back from the $1.40 level many analysts think would be too strong for the fragile eurozone economy in the eyes of ECB policymakers. At 1125 GMT it had recovered some ground to trade little changed on the day at $1.3735.

Spanish and Italian yields were flat on the day around 3.24 per cent and 3.3 per cent, after having slipped earlier to eight-year troughs of 3.2 per cent and 3.27 per cent, respectively.

Portugal’s 10-year yield dipped below four per cent for the first time in over four years. The ECB sets policy on Thursday next week, when it will have the euro zone-wide flash inflation estimate for March due on Monday. Economists expect that to slip to just 0.6 per cent, well below the ECB’s target of below but close to two per cent.

Europe’s main equity markets were all higher, posting early gains of up to four fifths of per cent.

The FTSE Eurofirst 300 index was up 0.4 per cent at 1327 points, on for its fourth straight day of gains as investors square positions at the end of the quarter.

After the respective eight and six per cent gains of the previous two quarters, equity investors have been much more cautious in the first three months of the year. The FTSE Eurofirst 300 is on track for a gain of around one per cent.

Europe followed Asia and emerging markets higher on the back of comments from China’s Premier Li Keqiang, who was quoted by state media as saying the government would roll out targeted measures step-by-step to aid the economy.

“The big question for China is whether it can deflate its credit bubble without creating a burst,” said Jeremy Batstone-Carr, analyst at Charles Stanley.

“The bounce we’re seeing today is a short-term effect.”

MSCI’s index of Asia-Pacific shares outside Japan added 0.7 per cent and Japan’s Nikkei closed at a three-week high of 14,696 points ahead of the end of their financial year on March 31.

Emerging markets showed signs of recovering from a bruising few weeks.

“The prospect of an economic rebound (in China) is likely to be priced into markets as policy support is announced. If so ... it seems plausible that H1 2014 will mark the low water point in emerging market equity performance,” wrote Barclays in a note to clients.

Gold looked to snap its broad losing streak this month, rebounding from Thursday’s six-week low to trade up 0.4 per cent on the day at $1,295.00 an ounce.

In the oil market, US crude futures were almost flat on the day at $101.43 a barrel.