Deflation Coming Closer

Yes, folks, it’s time for one more article on Europe’s deflation threat. This one adds a bit more to the picture of just how dangerously close Europe is to deflation.

On June 3, The Guardian reported:

The European central bank will almost certainly act this week to breathe life into the eurozone’s struggling economy after a shock fall in inflation, economists said. An unexpected fall in annual inflation to 0.5% in May from 0.7% in April appeared to seal the case for additional stimulus when the ECB announces its June policy decision on Thursday. It remains well below the ECB’s target of just under 2%, and surprised economists polled by Reuters who had forecast no change.

The “Thursday” that the Guardian refers to is, of course, last Thursday’s ECB meeting where they decided to introduce negative interest rates on banks’ overnight deposits. Banks now pay a penalty for depositing money with the central bank, a move that the ECB hopes will encourage banks to lend even more aggressively to the private sector.

The problem is that the private sector in Europe in general does not have enough confidence in the future to take on more debt. Those that would gladly borrow more money are probably not credit worthy, due to half a decade of recession, unemployment and struggling businesses.  Banks therefore end up with piles of liquidity they cannot make money on – unless they lower their credit standards.

Hopefully that will not happen. Back to The Guardian:

Christine Lagarde, the head of the International Monetary Fund, has been among those to raise concerns that “lowflation” will persist against the backdrop of a sluggish recovery in the 18-nation eurozone, urging the ECB to act. The fear is that weak price pressures could ultimately trigger a dangerous deflationary spiral, where consumers and businesses put off spending amid expectations that prices will fall further still. May’s fall in inflation dragged the annual rate back down to March’s four-and-a-half year low. Eurostat, the region’s statistics office, said food, alcohol and tobacco prices rose by just 0.1% in May compared with a year earlier, while energy prices were flat, as were non-energy industrial goods prices.

And this after years with a money supply that has increased several times faster than money demand, leaving plenty of new liquidity out in the economy.

All this with no effect on GDP growth. Back to The Guardian:

A sustained recovery has yet to take hold in the eurozone, with growth slowing to 0.2% in the first quarter, down from 0.4% in the previous quarter. There was some slightly better news from the labour market on Tuesday, as the unemployment rate fell unexpectedly to 11.7% in April, from 11.8% in March. The number of people out of work fell by 76,000 to 18.75 million. But the headline figure hid big disparities between the 18 member states. The lowest jobless rates were recorded in Austria at 4.9% and Germany at 5.2%. Greece had the highest rate, at 26.5% in February, followed by Spain at 25.1%. Youth unemployment also fell in the eurozone, by 202,000 to 3.38 million people. The rate fell to 23.5% from 23.9% in March. But more than half of young people in Greece and Spain do not have a job.

Small changes back and forth in unemployment make no difference over time. It would take a closer look at employment rates and similar data to find out if this is indeed the beginning of a recovery, or simply an exit from the workforce entirely. The abysmal GDP numbers would indicate the latter.

With no recovery in sight, deflation is still a real possibility in Europe. It is definitely more likely than a sustained recovery.