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Inflation

Ultra-low eurozone inflation worries ECB

Consumer price inflation in the eurozone remains very low, leading economists to worry that persistent price deflation could set in - a condition that could increase the risk of a general economic depression.

Eurozone inflation was 0.5 percent compared to the same month a year earlier in June, according to the European statistics agency Eurostat. That's well below the European Central Bank target rate of just under two percent.

In an effort to boost lending and stoke economic activity in the eighteen-member eurozone, the European Central Bank (ECB) in June reduced its core lending rate from an already low base to an extraordinarily low 0.15 percent.

It also introduced an unprecedented negative interest rate - a penalty - on reserves held by banks in their accounts at the central bank, in an effort to induce them to increase their lending activity. The penalty rate is minus 0.10 percent.

But eurozone inflation nevertheless remained deep within what ECB chief Mario Draghi has called the "danger zone" of year-on-year price rises below 1 per cent, where they have been since October.

If deflation sets in, the European economy will face additional risks. Deflation means that debtors' debt loads, considered in terms of the real purchasing power of the money they owe, effectively get heavier.

Deflation - When Everything Gets Cheaper!

Moreover, if expectations of price deflation become strongly anchored, consumers are likely to begin deferring purchases in the hope that prices will decline further. That means deflation tends to depress consumer demand.

Depressed consumer demand slows economic activity and reduces GDP. When aggregate demand declines, investments in new plant and equipment tend to be deferred, factories reduce their output, service businesses lay off staff, and people lose jobs - which leads to further reductions in aggregate demand..

The price of some goods have already begun to deflate. Food, alcohol and tobacco decreased in price by 0.2 percent compared to the same month a year earlier.

June inflation was also very low - 0.7 percent - for all the European Union member nations taken together, including the eighteen eurozone members - the countries which use the euro as their currency - plus the ten member states that use their own currencies, Eurostat reported.

nz/cjc (dpa, Reuters, AFP)

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