Eurozone slides into deflation

Jul 03, 2009

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The annual rate of consumer price inflation in the eurozone fell to -0.1% in June, the first negative reading since the single currency's inception. The fall was due to the decline in oil prices over the past year and the overall slide in demand amid the deepest recession since the war. Germany's inflation rate has fallen to zero, while prices have fallen over the past three months in Ireland and Spain. Meanwhile, Ireland reported an 8.5% slide in annual output in the first quarter.

What the commentators said

Most expect the eurozone's inflation rate to turn positive again in a few months, but there is a risk of a "full-blown deflation", said Ralph Atkins in the FT. When deflation becomes entrenched, stagnant or falling incomes and rising real debt burdens lower spending. This further lowers employment, demand, and hence prices.

The economies where housing and credit bubbles have burst, notably Ireland and Spain, are most vulnerable. In Spain unemployment is at 18% and domestic demand slid by 5.3% in the first quarter. Core inflation (minus food and energy) in both countries has turned negative, said Ben May of Capital Economics. And in the eurozone as a whole it is set to "decelerate considerably".

Europe's banks have received liquidity injections from the European Central Bank but, fearful of spiralling loan losses, they're "likely to hoard the cash rather than lend it on", said Ian Campbell of Breakingviews. The credit squeeze continues: the annual growth rate in private-sector lending has slumped to a record low of 1.8%. The eurozone is likely to underperform the US and Britain this year and "a recovery remains some way away", said May.

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