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Euro zone inflation hits record low

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Consumer prices fell by a more-than-expected 0.6 percent – matching July 2009’s record low. A significant portion of the fall in inflation can be attributed to the plummeting price of energy, which fell 8.9 percent year-on-year, but food, alcohol and tobacco prices were also down, as were non-energy industrial goods. Falling energy costs can be regarded as ‘good’ deflation, as they should relieve pressure on household budgets and boost consumer spending. However, more worrying is the downward trend in the core rate of inflation, which excludes items such as food and energy, whose prices are largely determined by global factors. This also fell to a record low in January of 0.5 percent (from 0.7 percent in December), reflecting the underlying weakness of the euro zone economy.

Deflation is now widespread in both the core and periphery of the euro zone, with Germany the latest to join the party. Prices in the currency bloc’s largest economy fell 0.3 percent in the year to January, figures released yesterday showed. The latest inflation rates for selected euro zone economies are shown below. There is a danger that the fall in energy prices could have ‘second-round’ effects, as companies in other sectors use their own falling costs to cut prices and gain market share. Workers whose disposable incomes have been increased by lower fuel prices might decide to settle for lower pay rises. Households might come to expect falling prices and defer non-essential spending decisions as they wait for prices to fall, leading to a deflationary spiral as we have seen in Japan.

Deflation is particularly worrying in the euro zone given the high levels of indebtedness in many members, as falling prices increase the real value of the debt, making these debts harder to service. However, there are tentative signs of improvement. Unemployment fell to a two-year low of 11.4 percent in December, though this still means 18.1m people are out of work across the euro zone. Meanwhile household spending in France rose by 1.5 percent in December, three times faster than economists had expected, and economic sentiment rose in Germany, Spain and Italy. All this suggests the ECB’s QE programme might benefit from a slight following wind in the months to come.

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