German Producer Prices in March declined by -0.7% versus -0.3% projected, contracting for the sixth straight month n a row. Analysts are beginning to worry about the prospect of deflation spreading throughout the Eurozone as highlighted by yesterday’s article in New York Times – and today’s German PPI data does little to alleviate those concerns.
Yesterday, NY Times pointed out that Spain, Luxembourg, Portugal and Ireland are all experiencing downward price pressures. However, it is Germany, as Eurozone’s largest economy, that is most troubling to policymakers. If Germany, much like Japan in the 1990’s slips into a deflationary spiral any attempts at stimulating the economy will become far less effective. In a deflationary environment consumers are reluctant to spend, believing that costs of goods and services will decrease in the foreseeable future. This behavior leads to a vicious cycle of contraction as businesses and consumers continually defer spending despite government’ s best efforts to jumpstart the economy.
The current worries in the Eurozone center around the fact that ECB has been slow to counteract these forces, continuing to focus on controlling inflation rather combating deflation. With the region mired in its worst recession since World War II and unemployment rolls increasing at an ever faster pace, the threat of deflation is becoming more serious each day. For the time being the EZ CPI data remains positive but very mild rising only 0.6% on a year over year basis. However, the dramatic declines on the wholesale level are likely to filter down to retail given the very weak state of consumer demand.
If deflation were to grip the Eurozone, ECB may have no choice but to lower rates below the 1% barrier and may even have to move to a Zero Interest Rate Policy if deflation takes hold. As a result of these problems EUR/USD has been hammered in the currency market for the past week and after a brief covering rally in Asia once again slid towards the 1.2900 handle in early European trade in the aftermath of the release. If the upcoming ZEW survey at 9:00 AM GMT is unable to offer any positive surprises, the pair could slip into the 1.2800s as the day progresses.
