Is Europe heading for deflation?

15th June, 2020

Lockdown restrictions continued to ease across Europe during May. Schools, shops, bars and restaurants began to reopen and quarantine restrictions were relaxed. During May, the Dax Index rose by 6.7% while the CAC 40 Index climbed by 2.7%. By the end of May, the World Health Organisation (WHO) had confirmed 2.1 million cases of COVID-19 across pan-Europe, with 180,085 deaths recorded.

The European Central Bank (ECB) expects the Eurozone’s economy to contract by between 5% and 12% this year with a medium scenario of -8%, according to ECB President Christine Lagarde. France fell into recession at the end of April, and Italy followed suit in May.

The pandemic has amplified the European financial sector’s existing vulnerabilities, according to the ECB’s Financial Stability Review. Key risks include “richly valued” asset prices, question-marks over the sustainability of sovereign and corporate debt, “fragile” investment funds, and pressure on banks’ profitability.

Concerns over the possibility of deflation in the Eurozone intensified during May. The rate of inflation in the region fell to 0.1%, pulled down by a 12% decline in energy prices. The news stoked expectations that the ECB would expand its programme of asset purchases in June. Eurostat reported that several individual eurozone members – including Greece, Ireland, Italy, and Portugal – experienced deflation during May. The ECB’s inflation target remains “below, but close to, 2%”.

The European Commission (EC) cut its economic forecasts for the Eurozone during the month; the EC now expects the Eurozone’s economy to contract by 7.75% this year. Germann and French economies are expected to contract by 6.5% and 8.2%, respectively during 2020. Meanwhile, Italy, Spain and Greece are all forecast to shrink by almost 10%. The Eurozone is predicted to rebound by 6.25% in 2021. However, the speed and strength of recovery in each member state will depend on the speed at which lockdowns are lifted and the economy’s exposure to tourist income. Structure, financial resources, debt levels, and individual government policies will also play a key part.

European Commissioner for the Economy Paolo Gentiloni commented: “Europe is experiencing an economic shock without precedent since the Great Depression. Both the depth of recession and the strength of recovery will be uneven”. He also warned that divergent performance from the individual member states “poses a threat to the single market and the euro area”.

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