Deflation Hits Eurozone

Eurozone inflation turns negative

By Ralph Atkins in Frankfurt, June 30 2009 11:03

Eurozone annual inflation has turned negative for the first time, complicating the job of the European Central Bank as draws a line under emergency measures to tackle continental Europe???s recession.

Consumer prices in the 16-country eurozone were 0.1 per cent lower in June than the same month a year before, according to Eurostat, the European Union???s statistical office.

It was the first time eurozone annual inflation had fallen below zero since comparable records began in 1991. Inflationary pressures in continental Europe are now lower than at anytime since at least the early 1950s, according to calculations by some economists.

The fall in prices reflected sharply lower energy costs but also the effects of the worst post-war economic downturn. The US had already reported year-on-year falls in consumer prices.

News that inflation had turned negative ??? and was massively undershooting the ECB???s target of an annual rate ???below but close??? to 2 per cent – came as the ECB prepares for Thursday???s interest rate setting meeting in Luxembourg.

Since last October, the ECB has slashed its main policy rate by 325 basis points to 1 per cent, and pledged to meet in full banks??? demands for liquidity ??? which resulted in it last week pumping ???442bn in one-year loans in the banking system.

But the ECB???s governing council is not expected to cut official borrowing costs further at this week???s meeting and analysts expect the main policy rate to remain at 1 per cent for many months ??? possibly well into next year or even beyond.

The ECB believes the impact of its measures have still to feed through into the economy. But it faces a difficult balancing act. Even though the inflation outlook justified further action, the central bank feared ???that more aggressive easing now could risk financial stability and or a too sharp acceleration of inflation over the longer-term,??? said Nick Kounis, European Economist at Fortis Bank.

Jean-Claude Trichet, ECB president, is likely to stress on Thursday that negative inflation will be only a temporary with a return to positive annual rates expected later this year. But ECB forecasts show inflation remaining well below 2 per cent in 2010 and the worry for ECB policymakers is that months of below-zero inflation rates will stoke fears of full-blown deflation ??? generalised and persistent falls in prices that wreak significant economic damage.

Meanwhile, credit figures released by the ECB just ahead of the inflation news highlighted how the liquidity it has pumped into the banking system have not yet stopped credit flows to the economy from being thrown into reverse. Businesses repaid a net ???5bn in loans in May, slowing the annual rate of growth in such loans to just 4.4 per cent. Even more dramatically, the annual rate of growth of borrowing by households turned negative, with loans down 0.2 per cent on the year.

The ECB has been stepping up its appeals recently for banks to pass on the extra liquidity they have been lent, but it could be some months before any extra lending to businesses and households shows up in official data.