Deflation in the European Economy

Yesterday we learned that France and Germany were making tentative steps out of recession with 0.3% increases in real GDP in both countries during the second quarter (April through to June). Today the latest consumer price data came out for the Euro Zone and they show that the single currency area is now firmly in the grip of price deflation.

The average annual rate of inflation for the sixteen nations that are participating in the single currency was -0.7% in July 20092, down from -0.1% in June. A year earlier the rate was 4.0%.

For the EU as a whole there remains wide variations in the rate of inflation. Deflation is happening in Ireland (-2.6%), Belgium (-1.7%) and Luxembourg (-1.5%), whereas CPI inflation is relatively high in Romania (5.0%), Hungary (4.9%) and Poland (4.5%).

The latest CPI inflation data for the UK was 1.8% in June - a tad below the inflation target of 2.0%.

Inflation in the Euro Zone is likely to remain low in the near-term:

1/ There is a growing margin of spare capacity in the EU economy with most countries fighting recession and operating with a large negative output gap

2/ The recession is having a dampening effect on wage pressures

3/ A stronger Euro against the US dollar is keeping a lid on the cost of rising international commodity prices

4/ Manufacturers and retailers have lost pricing power because of the economic downturn