Fall in eurozone inflation rate fuels deflation concerns

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Calls for European Central Bank action to help protect the eurozone's fragile recovery have grown after the release of inflation and jobless data.

Official figures showed that eurozone inflation fell to 0.7% in January, down from 0.8% in December and further below the ECB's 2% target.

It has fuelled worries about whether the euro bloc could suffer deflation, potentially de-railing economic growth.

Separate data showed the unemployment rate in December was unchanged at 12%.

Downward spiral

The European Union's statistics agency, Eurostat, said that although there was a 1.7% rise in the cost of food, alcohol and tobacco in January, energy costs fell 1.2%.

Many economists had forecast the eurozone's inflation rate would rise slightly in January. The rate last touched 0.7% in October, which was the lowest reading for the 18-nation eurozone in almost four years.

Start Quote

The big challenge is exactly what to do. With the store cupboard of conventional measures largely bare, any policy action is likely to be unprecedented”

End Quote Luke Bartholomew Aberdeen Asset Management

Concerns about possible deflation - where the price of goods and assets are locked in long-term decline, hitting corporate profits, wage growth, and tempting consumers to delay purchases in the hope of further falls - have grown in recent months.

At last week's World Economic Forum, in Davos, Christine Lagarde, head of the International Monetary Fund, said eurozone inflation was "way below" target and that the risks to the bloc's fragile economic recovery should not be ignored.

Mario Draghi, president of the ECB, has said that although inflation was "subdued, and expected to remain subdued" for about two years, he was confident that it would return to target. But he added that the ECB was ready to act if necessary.

Meanwhile, separate figures from Eurostat on Friday showed there were about 19.1 million jobless in the eurozone in December, down 129,000 from November 2013, but up 130,000 from December 2012 when the debt crisis was at its peak.

Eurostat also said the unemployment rate for November had been revised down from 12.1% to 12%.

Analysis

Deflation, if it's persistent, can be a very nasty problem. Consumers have an incentive to delay buying things that might cheaper in the future. It can also aggravate debt problems. Company revenues may fall, personal incomes can drop in cash terms, but debts do not. You still have to make the same payments.

And the eurozone has plenty of debt problems, scattered through the private sector and of course among financially stressed governments. Falling prices can hit the income they get from tax revenues. There has been some progress in getting to grips with government borrowing needs, so a prolonged period of deflation would be a very unwelcome setback.

In fact many of those struggling finance ministers would probably secretly welcome a period of above-target inflation to make the debts a little more manageable. That's not on the near horizon. Instead the European Central Bank is coming under pressure to do something dramatic to ward off falling prices.

"The job crisis is far from over and efforts must continue at EU level and in member states to fight this scourge and ensure an inclusive and sustainable recovery," said EU employment commissioner Laszlo Andor.

Rate cut?

Aberdeen Asset Management analyst Luke Bartholomew said it was "now more likely than ever that Draghi is going to have to step in with some extraordinary measure to stave off deflation.

"The big challenge is exactly what to do. With the store cupboard of conventional measures largely bare, any policy action is likely to be unprecedented."

Jonathan Loynes, chief European economist at Capital Economics, said action from the ECB could come as early as next week, when policymakers meet.

He said: "Unemployment remains very close to its record high, suggesting that there is still considerable slack in the currency union's labour market.

"Against this background, and with the strong euro adding to deflation risks, the pressure on ECB president Mario Draghi to follow up his recent dovish words with further policy action is very strong."

He said that Mr Draghi appeared "lukewarm" about injecting more money into the eurozone, through measures such as quantitative easing. "Another interest rate cut is perhaps the most likely move, if not next week then in March," Mr Loynes said.

The ECB cut its key interest rate to a record low of 0.25% in November.

Frederik Ducrozet, a senior eurozone economist at Credit Agricole, said: "The ECB's sensitivity to inflation data was already high and even a small surprise like this one today might tip the balance towards more easing.

"I would not expect action next week, rather a stronger wording for a possible cut later, possibly in March," he added.

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