European currency hits 9-year low versus US as Europe faces deflation and further stimulatory measures

The New Zealand dollar pushed on to a 21-month high against the euro yesterday as the spectre of deflation swept through Europe's financial markets.

The kiwi traded as high as 65.93 euro cents and touched a fresh post-float high against the Australian dollar of 96.52 Australian cents, reflecting concerns about Australia's dimming economic prospects.

While the kiwi has been declining against the US dollar, exporters with big exposure to Europe, Australia and Japan will be feeling the pinch as offshore sales are converted back into relatively fewer New Zealand dollars.

In Europe, the euro fell to a nine-year low against the US dollar after a report showed eurozone inflation turned negative for the first time since 2009. Consumer prices in the 18 countries that share the euro fell 0.2 per cent in December from the year earlier.

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Deflation is seen as a greater risk than inflation because it encourages consumers to defer spending in the expectation of cheaper prices in future, which in turn slows down economic activity.

But economists say there is "good" and "bad" deflation. "Bad deflation occurs when prices fall rapidly, for a generalised softness in prices, and that can encourage people to defer spending for prolonged periods," Westpac senior economist Satish Ranchhod said.

"But there is also good deflation, such as when you have a sharp decline in petrol prices as we are seeing now," he said. Good deflation meant households would get a boost to their incomes, which can encourage spending, he said.

Speculation that the European Central Bank (ECB) would approve a fresh round of stimulatory measures at its meeting on January 22 has now become very strong, putting more downward pressure on the euro.

"More so than ever, people are expecting the ECB to act," Bank of New Zealand currency strategist Raiko Shareef said. "I would say the majority expect some sort of fresh easing policy on January 22," he said. "That's the driver of kiwi/euro at the moment - New Zealand is in pretty good economic shape, Europe is not."

Closer to home, falling oil prices will have implications for New Zealand's central bank, which is mandated to keep inflation with a 1 to 3 per cent annual target range.

Bank of NZ head of research Stephen Toplis expects annual inflation to come in at 0.8 per cent for the December quarter just passed, falling to 0.2 per cent in the current March quarter, compared with the Reserve Bank's own forecasts of 1.0 per cent and 1.1 per cent, respectively.

While the bank will likely be comfortable "looking through" the first round impact of lower oil prices, it will be watchful of signs of medium term inflation expectations softening.

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"The upshot of this is that the Reserve Bank seems more and more likely to sit on its hands for a very long time," Toplis said in a commentary. The Reserve Bank's official cash rate now is 3.5 per cent.additional reporting, BusinessDesk