Eurozone inflation fall raises prospects of damaging deflationary spiral

by The Daily Lede

Eurozone inflation fall raises prospects of damaging deflationary spiral

  • Surprise fall from 0.7% in April to 0.5% in May means European Central Bank expected to act this week with interest rate cut
  • sustained recovery has yet to take hold, with growth slowing to 0.2% in the first quarter, down from 0.4% in the previous quarter.

Eurozone inflation fell unexpectedly in May, raising the prospect of a damaging deflationary spiral and sealing expectations that the European Central Bank will act this week.

The annual rate fell to 0.5% from 0.7% in April, according to a snapshot estimate from the European statistics office, Eurostat, dragging inflation back down to March’s four-and-a-half year low.

It remains well below the ECB’s target of just under 2%, and surprised economists polled by Reuters who had forecast no change.

Eurostat 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. Core inflation, which strips out energy, food, alcohol and tobacco, fell to 0.7%, from 1% in April. Economists said the fall in that rate partly reflected a normalisation following April’s Easter-related rise, but also indicated broader weakness in underlying price pressures.

James Ashley, chief European economist at RBC Capital Markets, described the data as “abysmal”, adding: “This latest easing in inflation is of genuine significance, in our view: although euro area inflation was as low as 0.5% as recently as two months ago, we could then dismiss some of the weakness as being due to transitory distortions around the timing of Easter, whereas this time, in our view, the 0.5% reading is a clean reflection of the dearth of inflationary pressures.

“It almost goes without saying that the ECB will be forced to act on Thursday. The fact that we have yet more downside news today merely serves to validate the seemingly universal expectations for action this week.”

Economists are expecting the ECB to cut the main interest rate from the current level of 0.25% at its policy meeting on Thursday in an attempt to prevent deflation in the eurozone and breathe some life back into the currency bloc’s economy. A sustained recovery has yet to take hold, with growth slowing to 0.2% in the first quarter, down from 0.4% in the previous quarter.

Economists are also expecting the ECB to cut the rate of interest paid on bank deposits, taking it from zero into negative territory.

There was some slightly better news from the eurozone on Tuesday as the unemployment fell unexpectedly to 11.7% in April, down 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.