Deflation fears and what it would mean

The Eurozone is on the brink of sliding into deflation after the economic disruption of the coronavirus pandemic dragged price growth in the bloc down to 0.1% in May, its lowest level for four years. The fall in inflation — which turned negative in 12 of 19 Eurozone countries in May — has added to investors’ expectations that the European Central Bank will inject more monetary stimulus into the economy when its governing council meets virtually next week. Economists worry that a prolonged period of deflation would be painful for the Eurozone as it would make high corporate and government debt levels even harder to manage as interest payments stay fixed but wages, prices and tax payments all fall in cash terms. Commentators believe steps must be taken to counter the significant risk of low inflation and the marked fall in economic activity from translating into a permanent reduction in expected inflation or into the possible resurfacing of the threat of deflation. Also as a result of the high levels of public and private debt in the euro area as a whole, this could trigger a dangerous spiral between the fall in prices and that in aggregate demand.

Price growth diverged between Europe’s largest economies, with inflation of 0.% in Germany, 0.2% in France and 1% in the Netherlands. But prices fell 0.9% in Spain and 0.2% in Italy. The lockdowns imposed in many European countries to contain coronavirus brought many activities to a standstill and are expected to lead to a record post-war recession this year. With economic output set to remain below pre-virus levels for the next couple of years, the ECB will keep policy ultra-loose for the foreseeable future. The ECB has flooded the financial system with cheap money in an attempt to stimulate activity and keep inflation from falling further below its target of just below 2%.  Meanwhile, Sweden revised up its first-quarter economic performance from its initial estimate of a slight contraction to growth of 0.1 per cent, as its no-lockdown approach to coronavirus helped prevent the deep recessions suffered by most other European countries.

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