Is the eurozone threatened by deflation?

Inflation in the euro zone has already weakened since the beginning of the year due to the fall in oil prices. And the Corona crisis is pushing prices down even further. The rate of inflation (HICP) in the Monetary Union fell from 0.3 to 0.1 percent in May, thus increasingly approaching zero. The question of whether other prices will also fall in the coming months and whether the euro zone could thus slip into deflation in the medium term will certainly occupy market observers a great deal of attention in the coming months.

A look at the main aggregates shows that the trend of falling inflation rates is largely due to falling prices for energy goods, while on the other hand food prices have tended to rise somewhat more strongly. Excluding these two components, and thus focusing on the core rate, the annual rate of change in consumer prices remained broadly stable in May at 1.2%.

In the short to medium term, different aspects have an impact on price developments. The negative output gap resulting from this year’s recession argues in favour of falling prices. In addition, uncertainty among consumers and companies is high. The longer the uncertainty persists, the greater the reluctance to invest and the greater the renunciation of consumption. Weak demand is then likely to depress prices.

With a stronger economic recovery, energy prices should also rise again somewhat and no longer put a brake on inflation. In addition, the increased savings following the forced consumer spending cuts in March and April should lead to higher consumer spending in the coming months.

And last but not least, businesses and households are currently being supported by massive fiscal policy measures. In addition, the extraordinarily expansive monetary policy of the European Central Bank is creating a favourable financing environment. The expansive economic policy thus represents a good springboard for economic recovery – and especially demand – after the lockdown.

All in all, we assume that the sum total of price-driving and lowering effects will more or less balance each other out. In the short term, the EMU inflation rate will be close to zero or slightly negative. From the turn of the year it should then rise again. However, we consider a strong and sustained overshooting of the inflation rate well above the two percent mark to be unlikely.

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