Eurozone Officially Enters Deflation for First Time

Deflation
A woman looks at a shop window as employees arrange clothing products in Athens November 10, 2014. Alkis Konstantinidis/Reuters

The Eurozone has slipped into deflation, official figures have shown on Wednesday, with prices in the euro area in December 0.2% lower than a year earlier.

The data falls way below the European Central Bank's (ECB) target of just under 2% inflation and worse than predictions of a 0.1% fall, and means that the Eurozone has gone into negative inflation for the first time since the financial crisis in 2009.

Low energy prices are mostly to blame, with energy costs falling 6.3% compared to a year earlier, driven by the plunging price of oil. Brent crude oil fell below $50 for the first time since 2009 early on Wednesday. Whilst it has since recovered slightly to almost $51 per barrel, it has still lost more than half its value since mid-2014.

Prices for food, alcohol and tobacco have remained unchanged from a year earlier, after rising 0.5% in November.

Prices for services however, which remained constant in November, have risen 1.2% from December 2013.

If energy prices are excluded from the inflation statistics, December's inflation rate for the Eurozone was the same as in November, at 0.6%.

Wednesday's data has raised the prospect of a major intervention by the ECB in an effort to stimulate the economy, with the central bank due to meet on January 22 to consider whether to extend its existing stimulus measures and start buying sovereign bonds in a new strategy of quantitative easing (QE). Yields on government bonds have fallen slightly from already very low levels.

However, according to Newsweek correspondent Andrew Davies, who recently wrote an in-depth feature on looming deflation in the Eurozone, the problem is a demographic one and intervention by the ECB will have little effect.

"One reason, which people don't pay enough attention to, is that there are just not enough people in the Eurozone," he says. "Who spends the money? People. Particularly the younger generations."

"Germany in particular is going to have a very serious problem in a few years - they are not going to have enough people of working age. Fewer people working means fewer people earning money, and this then means less demand," he says. "We have a structural problem where demand is flat-falling."

Deflation - the reduction of the general level of prices in an economy - is an unusual phenomenon. "It is a bit odd to talk about deflation as a bad thing - we should be happy when things are getting cheaper," he continued.

"But it isn't really the deflation itself that is a bad thing, but what it tells you about what is going on in the world. And what it tells you is quite scary."

"At present, the Eurozone has a major shortage of demand and confidence. People are scared to buy and they are scared to borrow. Also, many have reached the limits of borrowing that they are comfortable with."

"The ECB will probably intervene, but only because they have to be seen doing something. I don't think it will do any good. The yields on EU bonds are already extremely low, and pushing them lower is not going to make any fundamental difference and certainly won't answer the problem."

The situation in Greece has also complicated matters, as the country has a huge amount of debt that it owes to those countries that helped to bail it out of its economic crisis. Inflation usually reduces the value of debt over time as wages go up but the price of the debt remains fixed. Falling prices means that debt essentially gets bigger, whilst the price of everything else falls.

According to Davies the fact that deflation had not been more publically forecast was largely to do with anxieties concerning it.

"Generally speaking, central banks are very nervous about deflation because it is very hard to get rid of once you've got it," he said.

"Look at Japan - they've had the problem for the better part of 20 years and they are still not out of it. In fact, I don't think they are any closer than they were 10 years ago. There is no quick fix to this problem."

Eurozone Officially Enters Deflation for First Time | Business