Eurozone inflation has fallen to the lowest recorded under two key measures, raising the risk of a textbook deflation trap if recovery falters or there is an unexpected shock.
Core inflation – stripping out food and energy – fell to 0.7pc, lower than at any time following the Lehman crisis.
“It's lower than when the European Central Bank was forced to cut rates in November,” said David Owen from Jefferies Fixed Income.
“A large number of countries across the periphery are either in deflation already or very close, and this is spreading to France. The ECB will have to do quantitative easing in the end,” he said.
Almost 25pc of the items in the price basket have dropped over the last year, the clearest evidence to date that the deflation ‘virus’ is becoming lodged in the system.
Assume (1) that the Germans are not going to change their anti-inflation stance, and (b) the ECB has reached the limits of their liquidity operations.
What happens next?
Do the peripheral countries rebel and revert to domestic currencies as they fall into deflation, debt traps, and a shrinking GDP?
Well if Greece has not reverted back to the Drachma after what they have been through and are still going through, it would appear that the exit barrier is very high indeed. That exit barrier is the benefit of holding a currency which is appreciating in domestic purchasing power (for the periphery)
Or is the size of coercive state spending ground down remorselessly, until taxes can be lowered and room made for private enterprise to rebuild a restructured economy in its, rather than the public sectors, image? Perhaps legacy sovereign debt will be written off when the corner is turned and the wealth creating private sector replaces the public sector in Spain, Italy Greece and so forth.
Can German levels of market priced labour productivity be achieved by the periphery is the key question here.
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