Eurozone on brink of deflation as pressure builds on ECB

Via Yahoo Finance

The eurozone is on the brink of sinking into dreaded deflation after clocking up it lowest rise in prices for four years.

Inflation dropped in May to 0.1pc year-on-year, down from 0.3pc, as tumbling energy prices and disappearing demand took their toll. Core inflation, which strips out food and energy costs, held firm at 0.9pc but economists warned pressure on prices will continue to build.

The fourth straight monthly drop in the headline inflation rate will increase the pressure on the European Central Bank (ECB) to stop the region sliding into deflation – with potentially severe consequences for debts, jobs and living standards.

Economists have predicted prices will start to fall across the eurozone this year despite the huge stimulus efforts of policymakers.

Bert Colijn, ING economist, said: “The severe economic fallout is having a deflationary effect, which means the ECB is likely to stay in a crisis-fighting mode for some time to come.

“Today’s data leave little to argue about the strategic course for the ECB.”

The ECB is expected to announce another huge increase to its money-printing programme as soon as next week as it fights the economic fallout of Covid-19.

Economists have predicted the ECB’s rate-setters could vote for a €500bn (£449bn) expansion of its pandemic bond-buying programme.

The coronavirus crisis has revived fears that dangerous deflation could rear its head in the region and become entrenched, with prices chasing each other lower.

Deflation occurs when prices keep falling and can be difficult to stop, triggering a vicious downward spiral.

It can tempt consumers to delay spending in anticipation of lower prices in future, pushing costs down still further. This can ultimately hit employment if wages are “sticky” and fail to pull back along with prices, forcing companies to cut costs by axing jobs.

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Slowing price increases will reignite long-running concerns about the region being stuck in a state of “Japanification” – a stagnation defined by tepid growth, ultra-low interest rates and deflationary pressures.

Economists played down the steady core inflation figure – which strips out products such as fuel, where wild swings are triggered by movements in the oil price – warning that the preliminary reading is captured using limited data. 

Jessica Hinds, of Capital Economics, said: “Disinflationary pressure is still likely to build.

“The core rate will not be able to hold up much longer in the face of the collapse in aggregate demand and subsequent slow recovery, as well as rising unemployment.”