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Deflation fears as eurozone price growth falls to four-year low

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 per cent 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.

Ignazio Visco, governor of the Italian central bank and ECB council member, said on Friday: “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.”

Mr Visco added: “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.”

His comments came after Italy increased its estimate for how much the economy shrank in the first quarter to a decline of 5.3 per cent from the previous quarter, which was the largest contraction since records began in 1996.

Price growth diverged between Europe’s largest economies, with inflation of 0.5 per cent in Germany, 0.2 per cent in France and 1 per cent in the Netherlands. But prices fell 0.9 per cent in Spain and 0.2 per cent in Italy.

Falling energy prices were the main reason for the decline in inflation from 0.3 per cent in April to 0.1 per cent in May. Excluding energy, food, alcohol and tobacco, core inflation held steady at 0.9 per cent. 

Inflation in the eurozone’s services sector rose slightly to 1.3 per cent in May, but price growth for non-energy industrial goods slowed to 0.2 per cent. Food, alcohol and tobacco prices surged 3.3 per cent, but this was offset by a 12 per cent drop in energy prices.

The lockdowns imposed in many European countries to contain coronavirus brought many activities to a standstill and are expected to lead to a record postwar recession this year.

French household consumption fell 20.2 per cent in April — the most on record — while Paris revised its first-quarter gross domestic product estimate from a contraction of 5.8 per cent to a slightly lower decline of 5.3 per cent. Germany continued to come through the pandemic in better shape than its neighbours, as its retail sales fell 5.3 per cent in April.

Jessica Hinds, economist at Capital Economics, said: “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 per cent. 

This encouraged eurozone banks to increase their lending to businesses by a record €73bn in April, driving up money supply by the fastest rate since the 2008 financial crisis, according to ECB data published on Friday.

Overall money supply in the eurozone surged to levels not seen since the global financial crisis 12 years ago, as overnight deposits and currency in circulation both also rose rapidly.

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