The looming spectre of deflation is stalking Eurozone economies as prices continue to fall, say economists.
The European Central Bank (ECB) is having less room to manoeuvre in a bid to stop deflation and Europe now faces years of economic struggle similar to Japan’s deflation-ravaged economy.
Such a scenario will drag countries like the UK into the mix, and the real worry is that deflation makes repaying sovereign debt almost impossible.
The upcoming scenario means investors will have pay more attention to companies with strong balance sheets and particularly those exporting to growing markets.
Eurostat, the statistics office of the European Union, has issued a flash estimate predicting inflation to come in at 1.2% for April, which is down from March’s 1.7%.
Inflation at 3-year low
The figure for April is well below expectations from most economists, who expected inflation would drop to 1.6% year-on-year.
If the estimates are correct, this is the biggest monthly drop in inflation since May 2009 and will put inflation at the lowest level since February 2010.
The fall is fuelled by a collapse in energy prices, down 1.7% year-on-year to March.
Economists fear austerity measures in the Eurozone along with a strong Euro, low demand and high employment are creating the perfect background for deflation.
Essentially, economic policies across the Eurozone have been aimed at restoring competitiveness via a favourable inflation differential, which means that inflation is lower in the periphery countries than with trading partners.
Along with austerity and pressure on wages, inflation is falling instead of going according to plan, which was to inflate gently as growth got under way.
However, this is not happening and even Germany is being pushed into deflation.
Devastating deflation
The consequences of deflation in Europe could be devastating because this is the worst possible outcome for those countries which are struggling with massive debts such as Greece, Italy and Spain.
Deflation increases the debt-to-GDP ratio which in turn makes it unaffordable to service sovereign debts.
News of potential deflation is not a surprise to the markets, which have anticipated the risk for some time.
Over the coming weeks, investors and savers alike will be watching to see whether the ECB cuts interest rates in a bid to stave off deflation and boost the economies of the Eurozone.
The rate already stands at a record low of 0.5%.
However, with the slowdown of Germany’s economy affecting all of the Eurozone, the likelihood is politicians and economists will move towards non-standard measures to tackle the problem.
