Europe’s Endemic Deflation Problem

Bloomberg News

Euro-zone inflation is low and getting lower. But trends elsewhere on the continent suggest this is not just the European Central Bank’s fault.

In fact, inflation has been falling steadily across the continent, whether economies have their own central banks or rely on the ECB, whether their economies are expanding strongly or flagging. Even where house prices are surging and households are awash in credit, consumer prices are falling.

Of course, part of this continent-wide downtrend will be down to subdued growth in the euro zone. A raft of GDP data are due for the single currency region on Thursday, likely to confirm the subdued pace of economic expansion across this region. Overall, euro-zone GDP is expected to have expanded 1.1% in the first quarter on the same three months a year earlier, mostly driven by growth in Germany.

What’s more, the prospects for further growth are clouded. Even Germany, which is expected to have expanded 2.2% in the first quarter compared with the same quarter a year earlier, is starting to raise concerns. German industrial production was disappointing in March and the latest ZEW survey of business expectations came in well below expectations, having been on a downtrend over recent months.

But sub-par euro-zone growth isn’t the only source of downward inflationary pressure. For instance, the U.K. is expected to expand by a relatively robust 3.4% this year and 2.9% next, according to the latest Bank of England projections. Yet not only is inflation currently well below the BOE’s 2% target, at 1.6%, but the central bank doesn’t expect it to return to target until 2017 at the earliest.

Indeed, a raft of European economies outside of the euro zone have also been flirting with falling prices. Bulgaria, Croatia, Sweden and Hungary–all countries in the European Union but outside of the euro zone and thus able to set their own monetary policy–have all suffered deflation this year. Undoubtedly some of the central banks, like Croatia’s, are constrained by a currency-targeting regime. But others like Sweden’s have more freedom to act and, indeed, are simultaneously experiencing a credit boom and housing bubble yet still struggle to generate positive inflation.

Nor is deflation purely a European Union phenomenon. Switzerland is outside of the community and yet has also suffered deflation this year.

Some economists think that European deflation has much more to do with the demographics of ageing populations and declining workforces than it does with central bank policy.
But no doubt, the European Central Bank faces ever growing pressure to do more to reverse the deflationary trap and get the region’s economies growing more robustly. The wider European experience suggests it faces a tough challenge.

• Alen Mattich

sourche:http://blogs.wsj.com/moneybeat/2014/05/14/europes-endemic-deflation-problem/