Wednesday, May 27, 2009

Prices Fall In Germany

From the FT.

German price falls add to ECB fear
By Ralph Atkins in Frankfurt

Published: May 27 2009 22:18 | Last updated: May 27 2009 22:18

German inflation has turned negative for the first time in more than 20 years, fuelling fears of a fall in prices across the eurozone that will add to pressures facing the European Central Bank as it grapples with Europe’s severe recession.

Consumer prices in Germany fell 0.1 per cent this month from a year ago on a European harmonised basis, the country’s statistical office said yesterday. The unexpected drop was the first negative annual inflation rate since comparable records began in 1996 and since March 1987 on the previous basis.

The German data meant eurozone figures due tomorrow were expected to show annual inflation in the 16-country region at about zero in May with a dip into negative territory likely in June, economists said. Spain, Ireland and Portugal – three of the eurozone countries worst hit by the global downturn – have already reported negative annual inflation rates.

Inflation has tumbled on the back of steep falls in oil and commodity prices but also on weaker economic activity. “Energy is behind the wild swings, but core inflation is easing quite a lot and that is because we have the deepest recession since the 1930s,” said Dirk Schumacher at Goldman Sachs in Frankfurt.

The worry for the ECB, which has ensuring “price stability” as its main task, is that falling headline inflation rates fuel fears of a damaging deflation phase – in which generalised price falls wreak significant economic damage.

The ECB has warned that headline eurozone inflation rates are likely to turn negative for some months and thus undershoot by a large margin its definition of price stability – an annual inflation rate “below but close” to 2 per cent. It argues short-term inflation trends are irrelevant for monetary policy and sees inflation rising later this year. More importantly, it sees long-term expectations for inflation still in line with its goal. Core eurozone inflation, which excludes volatile energy and unprocessed food costs, has remained positive – except in Ireland.

However, Julian Callow, European economist at Barclays Capital, warned negative headline inflation would create “an important communication challenge” for the ECB. The risk was that a bout of “benign deflation” became malign, he said. The speed at which inflation had eased in Spain and Ireland, suggested that prices were proving more responsive to the crisis than might have been expected, Mr Callow argued.

Since last October, the ECB has slashed its main policy rate by 325 basis points to 1 per cent, the lowest ever. Jean-Claude Trichet, ECB president, has been careful not to rule out further cuts in interest rates or additional emergency measures. However, next week’s meeting is expected to see official interest rates left unchanged.

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