In the danger zone

In the danger zone

The euro area is getting perilously close to deflation

Source : From the economist print edition

IF FURTHER proof was needed that the euro crisis has ended as far as bond markets are concerned, it was provided by Ireland’s successful bond auction on January 7th. Less than a month since exiting its bail-out the Irish government raised €3.75 billion ($5.1 billion) in an issue of ten-year bonds that was nearly four times oversubscribed. Such was the appetite of investors that two days later Portugal tapped the markets to strengthen its chances of an exit in 2014.

But the legacy of the acute phase of the crisis, when weak governments on the periphery of the euro area were besieged by bond markets, remains a grim one. The euro-wide unemployment rate stayed stuck at 12.1% of the labour force in November, according to official figures published on January 8th. It has now stood at this record high in the 15-year life of the single currency since April 2013 (see chart).



Even so, unemployment across the euro zone does appear to have stabilised. The hope now is that it may start to edge down as a weak recovery continues. An index of private-sector output compiled by Markit, a data provider, suggests that the euro area grew by 0.2% in the final three months of 2013. That outcome would be consistent with earlier feeble expansion of 0.3% in the second quarter and 0.1% in the third.
Set against that modest hope is a larger fear about consumer-price inflation, which has become worryingly weak. The headline rate fell to 0.8% in the year to December. The core rate, which strips out more volatile items like energy and food, dropped to 0.7%, the lowest ever since the euro started in 1999.
Inflation is now uncomfortably far beneath the target rate set by the European Central Bank (ECB) of below but close to 2%. When overall inflation is so weak, it makes it harder for countries on the periphery to regain competitiveness by keeping their prices down as those in the core rise. And it raises the risk of outright deflation. If prices were to start falling, it would intensify the euro zone’s woes which are bound up with excessive debt, both public and private, in the most vulnerable economies. Deflation would cause that debt to rise in real terms. It could also stymie the recovery as people delay purchases because they will become cheaper.

The ECB responded to the sharp fall in inflation last autumn by cutting its main lending rate in November, to 0.25%. Its council was not expected to change policy settings at its meeting on January 9th, after The Economist had gone to press. But if inflation weakens further the ECB may have to embrace radical remedies, such as setting negative interest rates on deposits that banks leave with it. 
Source : From the economist print edition
                                     

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