Slowing price fall raises Europe recovery hopes

August 31, 2009

, BRUSSELS, Aug 31 – Consumer prices in the eurozone fell by 0.2 percent in August over 12 months — far less than the record 0.7 percent fall in July, EU data showed on Monday, boosting hopes of an economic rebound.

Preliminary August figures from the official Eurostat EU data agency marked the third month of a drop in prices, the first ever decline since the euro bloc was formed in 1999 and a remarkable U-turn for Europe\’s economy.

The downward trend began in June with a 0.1 percent fall in prices across the 16-nation bloc.

The markedly reduced rate of price falls in August is "clearly primarily due to oil prices falling at a significantly reduced rate year-on-year," said Howard Archer, chief European economist at IHS Global Insight.

"It seems highly probable that July marked the deepest deflation in the Eurozone and consumer prices will turn positive year-on-year within the next couple of months," he added.

Nevertheless, eurozone consumer price inflation seems highly likely to remain below the ECB\’s target of close to, but just below, two percent for some considerable time to come.

This is "due to underlying inflationary pressures being held down by large and still expanding output gaps across the region, low capacity utilization, high and rising unemployment, muted wage growth and a relatively strong euro," said Archer.

After hitting a record high of four percent in June and July 2008, eurozone inflation has fallen sharply as oil and other commodity prices have collapsed in the face of the global economic downturn.

A key inflation dampener is that "food inflation is likely to have remained subdued, while core prices probably continued to slow gradually," said Tullia Bucco, economist at UniCredit Research.

While the prospect of falling prices may delight consumers, it can wreak havoc on the broader economy as households put off purchases hoping for future bargains, undermining demand and investment in new production.

That then puts further pressure on employment, causing further falls in demand and so setting up a vicious circle which can potentially cripple an economy.

Bucco added that with the inflation rate set to remain dampened for the foreseeable future and the credit downturn in full swing, "we see a strong case for a steady refi (interest) rate throughout 2010".

Analysts expect the European Central Bank to keep rates at historically low levels on Thursday, as it waits to see if the tentative signs of improvement in the economy bloom into a full-blown recovery.

Most economists expect that eurozone deflation will be relatively brief, ruling out a longer downward spiral in prices like the one during Japan\’s "lost decade" in the 1990s.

The slowing in eurozone price falls is the latest in a string of data suggesting that Europe\’s economy is emerging, though not unscathed, from the global downturn.

Last week figures showed European business and consumer confidence firming in August for a fifth month running.

Recent data has also shown European factory orders up, with the eurozone monthly trade surplus doubling.

Germany and France have lumbered out of recession and very nearly brought the rest of the eurozone with them.

However amid fears of double-dip recession, EU commission chief Jose Manuel Barroso last week warned that Europe\’s economy has not made a "firm recovery" from the crisis and the situation remains "very volatile."

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