LONDON — The deflation demon has finally landed in Europe, adding to multiple economic troubles in the region and raising the specter of long-term price stagnation and sluggish growth.
Eurostat, the statistical office of the European Union, said in its monthly preliminary “flash” report this week that euro-area inflation had fallen to minus 0.2 percent in December, from November’s plus 0.3 percent, driven by a fall in energy prices.
On Wednesday, the price of Brent crude oil dropped below $50 a barrel for the first time in nearly six years.
Eurostat said prices remained stable for food, alcohol and tobacco. The report said the only annual increase is expected for services. The final report for December will be released on Jan. 16.
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The December figure was a worst-case scenario for many: Last week, European Central Bank president Mario Draghi hinted in an interview with a German newspaper that he was already bracing for the negative growth rate, and was preparing to strengthen the bank’s fiscal stimulus measures to breathe some life into the region’s economy.
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“If inflation remains low for a long time, people might expect prices to fall even further and postpone their spending. We are not there yet. But we need to tackle this risk,” he told Handelsblatt on Jan. 2.
“We have to avoid too-high inflation and we have to avoid too-low inflation as well….We are making technical preparations to alter the size, pace and composition of our [fiscal stimulus] measures in early 2015, should it become necessary to further address risks of a too-prolonged period of low inflation. The Governing Council agrees unanimously on that.”
An ECB policy meeting is set for Jan. 22, where all eyes will be on Draghi’s next moves.
Now that deflation is a reality, retail and luxury industry observers say there are short-, medium- and long-term issues that threaten Europe. “Deflation does not create an issue in the short term, but does create a big problem in the medium term,” said Luca Solca, managing director at Exane BNP Paribas.
“The problem is that deflation would mean that government debt levels continue to grow and solvency would continue to reduce. How are governments, the European Union and the ECB going to address this? So far, nobody knows — what we know is that more and more austerity in the long term brings bankruptcy.”
The Greeks are grappling with that very problem. The country heads to the polls on Jan. 25 and if the antiausterity, left-wing party Syriza wins, it could mean a major renegotiation of the country’s bailout deals with the EU, and precipitate a Greek exit from the euro.
Deflation also brings with it other short-term woes. George Wallace, chief executive officer of the European consultancy MHE Retail, said it takes a wide-ranging toll on consumers, employers and retailers alike.
“We’ve lived in an era of low inflation for quite some years now, but once deflation occurs, it’s a negative sign to markets: consumer confidence falls, retailers have no chance of putting prices up, and wages are flat. Retailers can’t cut their rents. It’s a pretty ugly situation for the retail model,” he said.
Wallace conceded that a scrap of silver lining does exist for retailers, with lower fuel, transportation and distribution costs.
That said, the biggest fear — the one lurking in many a European mind — is that of prolonged deflation, similar to Japan’s “lost decades” of economic growth and stagnating prices that ran from 1991 to 2000 and from 2001 to 2010.
“Everyone fears deflation settling in. They look at how it affected the Japanese economy, and it’s a worry for businesses,” said Wallace.