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Eurozone heads towards 'protracted' deflation as bloc hit by record price drop
Eurozone prices suffered their joint biggest drop in the single currency's history in January, sparking fears that the bloc could sink into a deflationary trap as falling energy prices began to feed through to the broader price chain.
Consumer prices in the eurozone were 0.6pc lower than a year earlier, following deflation of 0.2pc in December, according to a preliminary estimate by Eurostat.
This is the biggest annual drop in prices since July 2009, when prices also fell by 0.6pc, and matches the biggest fall since the euro was launched in 1999. Economists expected prices to fall by 0.5pc in January.
The decline was led by a 8.9pc annual fall in energy costs. However, there were also signs that the recent tumble in the oil price was spilling over to the wider price chain.
Core inflation - which strips out volatile elements such as food and energy costs - rose by 0.6pc in the year to January, from an annual increase of 0.7pc in December.
A spokesman for the European Commission said the current period of falling prices did not signal a "self-perpetuating" deflationary spiral, but economists warned that the eurozone could be headed towards a "protracted" period of deflation.
"The drop in core inflation almost certainly reflects the continued weakness of demand in the eurozone economy, and the associated vast amount of spare capacity," said Jonathan Loynes at Capital Economics.
Falling oil prices are expected to boost growth as cheaper petrol costs put more money in consumers' pockets. However, Mr Loynes said there was a risk that deflation could persist, even as oil prices and employment rates recover.
"There are some signs that growth might be picking up a bit and today's labour market figures - showing a drop in the unemployment rate from 11.5pc to 11.4pc in December - provide some hope that the labour market is still improving, slowly. But with growth likely to remain too weak to erode spare capacity to any significant degree, core inflation could continue to drop, raising the risk that deflation persists even after downward energy effects begin to fade."
Economists at BNP Paribas expect headline inflation to remain negative for the rest of this year, with an average rate of -0.7pc.
Deflation poses a threat to economies when expectations of price falls become entrenched. If consumers believe prices will be lower in the future, they put off purchases, which forces companies to cut prices and wages.
Falling wages and profits reduces tax revenues, pushing up government debt as a proportion of gross domestic product (GDP). Policymakers tighten budgetary policies to compensate. A vicious cycle may take hold, leaving economies in a Japanese-style deflationary trap.
Earlier this month, the European Central Bank (ECB) announced a €1.1 trillion quantitative easing programme to try to jolt the eurozone out of its chronic malaise and steer inflation back to its target of just below 2pc. Bond buying will begin in March.
"An energy-induced fall in inflation will help to boost consumers' spending power and is reflected in our forecast for higher consumer spending in the eurozone, particularly in Spain," said Janet Henry, chief european economist at HSBC.
Separate data showed annual inflation in Spain fell to -1.5pc in January, representing the sharpest decline since 1997. However, economic growth has remained robust. The economy grew by 1.4pc in 2014, and has now expanded for the sixth consecutive quarter.
However, Ms Henry added: "There is also a risk that, with inflation and inflation expectations already at such low levels, falling oil prices could destabilise inflation expectations, particularly in the corporate sector,"
"Obviously the ECB is hoping that its recent announcement of QE will help to bolster confidence, support activity and raise inflation expectations but, given the sharp declines in energy prices it must be hoping that the weaker euro will also help not just through the export channel but also feeding through into higher import prices."
[Source: By Szu Ping Chan, The Telegraph, London, 30Jan15]
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