The European Central Bank has declared victory over deflation in a watershed shift in policy, clearing the way for an end to negative rates and emergency bond purchases after years of deep economic malaise.

Triple tail-winds from QE, a cheap euro, and the end of fiscal austerity have all combined with powerful effect, at last lifting the economy out of a low-growth trap, or ‘Lost Decade’ as some economists describe it.

A blizzard of new figures paint a picture of accelerating growth across the region, with with unemployment falling to an eight-year low of 9.5pc - though it is still twice the level of the Anglo-Saxon and non-euro Nordic states. The eurozone’s jobless rolls have dropped by 1.24 million over the last year.

“Since the crisis we have had serious concerns about deflationary risks on several occasions in the euro area, but now we can say they have disappeared,” said Peter Praet, the ECB’s chief economist.

The comments are significant since Mr Praet has long been viewed as an arch-dove on the ECB’s executive council. Analysts at Citigroup say that German-led hawks in Frankfurt appear to be gaining the upper hand in their fight against quantitative easing (QE), raising the risk of a tightening signal over the next two policy meetings.

Mr Praet said last year’s blast of stimulus by G20 authorities in response to the Chinese currency panic had averted a worldwide downturn and was now feeding through into full-blown recovery.  “This coordinated reaction was very effective,” he told the Spanish newspaper Expansion.

What is not yet clear is whether the eurozone is entering a virtuous circle - driven by rising investment - or whether the current cyclical recovery is largely a sugar rush that will fade as stimulus is withdrawn.

David Fuller's view

This is the second time in the last fortnight that AEP has reported a change in sentiment across at least the North American and European economic scene. Financial sector euphoria evidenced shortly following Donald Trump’s election victory has given way to a more sombre mood. 

The previously lagging S&P Banks Industry Group Index outperformed during the Trump rally.  JPMorgan CEO Jamie Dimon led the high-profile cheerleading, talking about the revival of ‘animal spirits’ in markets.  Many stock markets rose as did government bond yields.  Industrial commodities also extended their rallies.

The switch flipped after mid-March and guest commentators on Bloomberg and CNBC warn that stock markets are vulnerable.  They are also singing the praises of US 10-Year Treasury Bonds (weekly & daily) where yields have fallen back from just above 2.60%, as they did in December, and are now testing 4-month range lows near 2.30%. 

Is this the pause that refreshes or have we entered a quite different phase?

In recent weeks I have been talking about the increasing possibility of stock market corrections.  Gains are due for some consolidation; there is plenty of uncertainty and seasonal factors during 2Q and 3Q are less favourable, on average.  However, I remain bullish of longer-term prospects and expect many technology shares to be among the top performers.  I also maintain that the secular bull market in government bonds is over, which means that yields will rise over the medium to longer term.

Meanwhile, here are some of the factors which will influence perceptions regarding deflation. Brent Crude oil near $40 would definitely be deflationary, while those fears would subside above $60.  Trump needs to pull a rabbit out of his hat by bringing forward economic policies of tax cuts and fiscal spending, and get them passed.  This would restore confidence in the economy, pushing US stocks and government bond yields somewhat higher.

(See also: Dimon Warns ‘Something Is Wrong With the U.S.’ , from Bloomberg)  

 Here is a PDF of AEP’s column.