World Economy

Eurozone Deflation Gathers Pace

Eurozone Deflation Gathers PaceEurozone Deflation Gathers Pace

Deflation across the 19 countries that use the eurozone currency is gathering pace.

In January, prices in the eurozone were 0.6% down on their levels a year ago. The figure shows the eurozone heading deeper into deflationary territory from December, when prices were 0.2% down on the year before, BBC reported.

A large contributor to falling prices is the cost of energy, with oil prices down almost 60% on the middle of last year. Energy prices plunged 8.9% in January.

If food and energy are stripped out of the calculations, eurozone prices were still rising at an inflation rate of 0.5%, down from 0.7% the month before.

The eurozone has only once before experienced deflation at these levels, in July 2009, as the region first went into recession following the financial crisis.

Last week the European Central Bank (ECB) launched a program aimed at pushing prices back up – known as quantitative easing (QE) – through which it injected around 1 trillion euros ($1.3t) into the economy.

Energy Prices

It was energy prices that have pulled the eurozone into deflation. But prices across the economy are rising slowly – well short of the European Central Bank's target of below but close to 2%.

So while cheaper energy is welcome news for a net importer of the stuff, as the eurozone is, the danger of a period of wider and potentially more damaging deflation is there. Debt is probably the big issue.

Deflation in effect raises real, inflation adjusted interest rates. It makes repayments more burdensome for borrowers with falling incomes, or for governments, tax revenues.

So the European Central Bank president Mario Draghi will no doubt see these figures as supporting the decision last week to launch a program of quantitative easing intended to push inflation higher.

Still, other new data show that a period of deflation doesn't necessarily mean an economy can't grow.

In Spain, where prices were falling for much of last year, the economy grew at a respectable 0.7% in the last quarter of 2014.

Stability Target

Christian Schulz, senior economist at Berenberg Bank said the latest figures showed that "the ECB was ... more than justified in taking aggressive action earlier this month.

"The multi-stimulus of cheap oil, a weak euro and aggressive monetary easing is now stabilizing expectations and will help the ECB reach its price stability target over time."

There was better news on eurozone unemployment, which fell to 11.4% in December, down from 11.5% in November.

Germany has a 4.8% unemployment rate. But 25.8% of Greece's labor force is out of work and Spain's jobless rate is 23.7%.

The euro was slightly higher after the news, rising 0.35% against the dollar to $1.1358, and sending the pound down 0.25% to €1.3276.

Strange Times for EU

There have been two important, connected economic developments in Europe. New official figures from Germany show that prices have fallen, by 0.5%, over the previous 12 months.

Meanwhile the Danish Central Bank has cut one of its main interest rates for the second time in a week. It is a rate paid to commercial banks for excess funds parked at the central bank. It was already below zero. Now it is even lower – minus 0.5%.

It means banks have to pay to leave money at the central bank, above certain specified limits.

Negative interest rates are another example of the strange financial world that has emerged in the aftermath of the financial crisis.

What is the connection between falling prices – or deflation – in Germany and the Danish central bank? It is about Denmark's 35-year policy of tying its currency, the krone, to the euro, and before that to the German mark.

That peg has come under increasing strain as the European Central Bank, the ECB, has taken steps to combat deflation.

Falling prices arrived for the eurozone as a whole last month. Germany was an exception to the pattern, but provisional figures for January show that is no longer the case. Deflation in Germany suggests the eurozone will experience faster falls in prices in the months ahead.