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Eurozone tips into deflation, sparking fears of more economic woe to come

European Central Bank is likely to take some sort of action later in January to stem the fall, head off recession

The eurozone’s inflation rate turned negative on Wednesday, raising fears that the 19-country economic bloc could succumb to prolonged period of deflation and adding urgency to the European Central’s Bank’s (ECB) efforts to jumpstart the zone’s woeful economic fortunes.

According to data released by Eurostat, the European Union’s statistical agency, the eurozone’s inflation rate in December slipped unexpectedly low to -0.2 percent, a fall of a half a percentage point from the previous month.

The tip into negative territory caps a poor 2014 for Europe's economic fortunes, which in addition to tanking inflation and high unemployment, has witnessed anemic growth as well as political turmoil. And adding to the downturn in the eurozone’s fortunes is the precipitous drop in energy prices in the last year, with barrels of oil now trading below $50 for the first time in six years.

"Without a rebound in oil prices, energy effects alone could push the headline inflation rate down towards -1 percent in the early months of this year and keep it in negative territory for most of 2015," said Jonathan Loynes, chief economist at Capital Economics.

If the prices continue heading even further south, then the eurozone could enter a deflationary spiral, it is feared.

According to common economic wisdom, while lowering prices may seem like a good thing for consumers in struggling economy for day-to-day budgeting, full fledged deflation can sap demand and consumption, as people hold off on spending on the expectations that prices will lower yet further.

A deflationary trend can also place greater burden on borrowers, as the real cost of servicing loans climbs with lowered prices.

Given the wide variation of economic fortunes among eurozone members, the ECB has found it difficult to correct course.

"If you were designing an economic nightmare, then, deflation or stagnation in Europe would be close to top of your list," wrote Guardian columnist and Channel 4 economics commentator Paul Mason.

According to EU data, while Germany’s unemployment rate stands at a healthy 5 percent, Greece’s hovers near 25 percent, with Spain nipping on its heels, and eight other eurozone countries registering at least 10 percent. 

Those numbers skyrocket when focusing on youth unemployment in the worst affected EU economies, to over 50 percent in both Spain and Greece, while only registering a slight uptick in Germany.

Unlike the Federal Reserve in the United States, the ECB has been reluctant to enact, or unable to agree upon, steps to more forcefully expand the money supply in the form of so-called quantitative easing. Those efforts by the Fed, which have held interest rates at near zero as part of a broader government bond-purchasing scheme, have seen more than $3 trillion enter the U.S. economy. In parallel, the U.S. economy, while still subject to stagnating wages and underemployment, is now on a relatively stronger economic footing than Europe.   

But the newest inflation data for the eurozone, which is well below the 2 percent inflation benchmark set by the ECB, will add to concerns that have been mounting from its president Mario Draghi that deflation may have to be nipped in the bud before its allowed to take root.

“We are making technical preparations to alter the size, pace and composition of our measures in early 2015, should it become necessary to further address risks of a too prolonged period of low inflation,” said Draghi in an interview with German newspaper Handelsblatt, last week. Many expect that that will take the form of some kind of official quantitative easing later this month.

“The risk cannot be ruled out completely, but it is limited,” he added of the likelihood of deflation, adding, “But we need to tackle this risk.”

The ECB has previously described a dip of below than 1 percent a “danger zone.”

Still, even in the case that the ECB announces its anticipated measures later this month, some question whether such a policy can overcome the conflicts simmering among Eurozone members.

“Disagreement on the governing council of the European Central Bank ensures a crabwise progression towards full scale government bond buying without which its inflation target will not be met,” said John Plender on Tuesday, writing in the Financial Times.

“A lot has been done within the eurozone to reduce the risk of widespread financial chaos. Instead, and after last year’s sharp and widespread compression, look for greater differences to emerge in the bond yields of some of the eurozone’s more vulnerable peripheral economies as markets pay greater attention to the reality of their divergent fundamentals,” wrote Mohamed A. El-Erian, chief economic adviser at Allianz SE and chairman of President Obama’s Global Development Council, for Bloomberg.

But the worry of sluggish global growth in the last year has also formed part of the backdrop for the eurozone’s difficulties. Ahead of the International Monetary Fund’s annual meeting with the World Bank last fall, IMF head Christine Lagarde warned of “the risk of a new mediocre.” She said, “The global economy faces the prospect of prolonged subpar growth, accompanied by high unemployment and rising inequality."

Sounding an even starker note looking ahead with a 2015 economic forecast for Europe, The Economist wrote, “There are now serious worries that the eurozone will succumb to a ‘triple-dip’ recession,” referring to a Europe that has twice suffered recession since 2008. Wednesday’s economic data is unlikely to brighten that sentiment.

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