Cheap Oil Deflation Returns to Europe

Consumer prices fell in the euro zone in December for the first time in more than five years, ushering in what some fear could be a new era of deflation leading to stagnation and even recession.
Some economists think deflation will empty stores of shoppers in Europe.

The threat of falling prices in Europe – which some economists fear may usher in a new recession – became an official reality Wednesday when a new report confirmed the first evidence of deflation since 2009.

Consumer prices in the 19-nation euro currency zone fell in December, by 0.2 percent from a year earlier, raising pressure on the European Central Bank to take action to stimulate borrowing and spending in the vast zone that now stretches from Dublin to Vilnius, Lithuania.

The decline in prices reported in a preliminary estimate by the European Union’s statistical agency confirmed the expectations of many economists.

But unlike the last signs of deflation at the height of the global financial crisis in 2009, when prices bounced back again quickly, economists expect the new downturn to last for quite a while in the absence of large government spending programs and continued austerity championed by Germany.

“The difference with 2009 is that this time around the negative rates are here to stay, at least for a couple of months,” Carsten Brzeski, chief economist of the Dutch bank ING-Diba in Frankfurt, told the Handelsblatt Global Edition. “The first quarter will probably be negative for the euro zone.”

But unlike the last deflation at the height of the financial crisis in 2009, when prices bounced back quickly, economists expect the new downturn to last for a while.

Although the report showed the euro zone moving statistically into a minor deflationary phase, economists cautioned against making alarmist predictions of a coming recession.

Many observers, including the central bankers at the ECB, are not yet ready to speak about deflation in the euro zone because the most recent price decline was set in motion by a narrow segment of consumer spending – falling energy prices.

Another measure of broader price development actually rose during the month.

Mr. Brzeski argued it’s really “all in the words,” adding that economists prefer to think of it as “negative inflation.”

Most economists define deflation as a broad-based fall in prices across a collection of consumer goods – a negative spiral that encourages consumers to delay buying goods in the hope of getting the same products even cheaper in the future.

“To really have deflation would mean that it’s well-anchored in the economy,’’ Mr. Brzeski said. “A deflationary spiral with consumers and businesses expecting prices to fall further.”

Wednesday’s reported price decline was clearly tied to falling oil prices, which have lost half their value over the last year amid increases in U.S. fracking production.

That trend appears to be unbroken. The price of Brent crude oil today on global markets dipped below $50 per barrel for the first time since 2009.

Excluding energy, “core” consumer prices rose 0.6 percent year-over-year in December. That was the same as a 0.6 percent rate in November. Excluding energy and food prices, which were flat on the month, and inflation even rose slightly to 0.8 percent.

Euro Area Annual Inflation-01 (2) zone ecb deflaation

Frederik Ducrozet, senior European economist with French bank Credit Agricole, told the Handelsblatt Global Edition that fears of deflation were exaggerated.

"I definitely see no deflation in those figures and I don’t believe it should be called deflation,” Mr. Ducrozet said.

“The main point is that it’s almost 100% energy driven, this decline,” he added.

Mr. Ducrozet said about one quarter of countries in the Eurozone are arguably in a real deflationary spiral – mostly southern European countries including Greece, Spain and possibly Portugal.

But psychology, after all, is everything. Even if the euro zone might not be in deflation just yet in the eyes of most economists, consumers might start to expect it.

For the ECB “inflation expectations” are what matters. The ECB president, Mario Draghi, has used the spectre of deflation as one of the reasons for pursuing his controversial policy of buying euro zone government debt in a version of a U.S.-style quantitative easing program.

The report today may give Mr. Draghi more evidence to begin the controversial purchases, which are expected to be announced this month.

“The ECB may take a little comfort from the fact that Eurozone core inflation actually edged up in December," Howard Archer, chief European economist for IHS Global Insight, said in a research note Wednesday. But more important, he said, was that December "finally saw prolonged very low Eurozone consumer price inflation morphing into deflation."

Mr. Archer said that while the ECB would normally overlook drops in the headline Eurozone inflation rate from falling oil prices, the bank will be concerned that the move into deflation in December may lead to a further significant weakening in inflation expectations.

Many are not yet ready to speak about deflation in the euro zone because the most recent price decline was set in motion by a narrow segment of consumer spending – falling energy prices.

The price report poses something of a puzzle for consumers. On its face, lower prices would seem to be a good thing, encouraging spending. Mr. Draghi put it simply last year when he said that lower prices mean you can “buy more stuff.”

Economists argue this is true in a solid economy. Case in point Germany, Europe’s largest economy, where a strong labor market has consumers feeling good about their incomes.

Unemployment fell to a new low of 6.5 percent in December, the lowest since German re-unification in 1990. Retail sales rose between 1.5 percent and 1.7 percent in 2014, according to an estimate from Germany’s statistical agency on Wednesday.

The situation is different if an economy is weak and in debt. Deflation means that debts owed to banks are harder to pay off. High unemployment means consumers are less likely to spend – regardless of whether prices are slightly cheaper than they were last month.

This is the situation that much of the euro zone is still in, particularly in the southern tier of economies – where about a quarter of the Spanish and Greek workforce is unemployed.

“Germany does not equal the euro zone. There are other countries where unemployment is much higher,” said Mr. Brzeski.

This provides a dilemma for the European Central Bank and has divided its governing council. German central bankers argue that temporary deflation is good for the euro zone – and raises spending power.

Southern European central bankers are pushing for more action to raise inflation, and are likely to get their way. The ECB is widely expected to announce a plan to purchase hundreds of billions of euros in government bonds at its next meeting in January.


Christopher Cermak has covered economics and central banks in Frankfurt and Washington, D.C. He is now an editor with the Handelsblatt Global Edition in Berlin. To contact the author: [email protected]