Eurozone in deflation: What does the future hold for Europe's finances?

The financial news of the week is a big story: the eurozone has seen a fall in inflation, as consumer prices fell in the region by 0.2 per cent. While not a huge amount, this still marks the first time the eurozone has seen such a decline since the financial crisis of five years ago, which is obviously not something most people want to see repeated.

However, the first reaction of many people was exactly that: sources from top economists to people on the street have been saying that the news is a sign that another financial crisis is about to hit the eurozone and by extension most of the rest of Europe. But is this really the case?

What does the drop in consumer prices really meant for the eurozone? Are there steps that can be taken to avoid an economic catastrophe? And what caused the issue in the first place? Here is our guide to what the future holds for the finances of the eurozone:

 

What happened?

On Wednesday (January 7th), an official eurostat report stated that the eurozone's annual inflation was expected to be -0.2 per cent for December 2014, down from 0.3 per cent in the previous month. Many analysts expected slight deflation, but only predicted a fall of 0.1 per cent.

This had several effects, some of which were quite severe. Firstly, many have now lost faith in the European Central Bank (ECB), which analysts were expecting to step in and take action to prevent further deflation. This did not happen, and soon oil prices were crashing as well.

At the lowest, oil fell below $50 (£33) per barrel. However, hard work by investors led to prices rising once more. Meanwhile, the euro fell to a nine-year low, reaching a value of just $1.1809. This could have a major effect on the overall economy of the eurozone.

 

What caused it?

The main culprit for the deflation is energy prices. The eurostat report showed that the price of food, alcohol, tobacco and non-energy industrial goods all remained the same, while services saw an inflation of 1.2 per cent. However, energy prices fell by a massive 6.3 per cent.

This has dragged inflation overall down to -0.2 per cent. The falling price of energy itself was called by the steep drop in oil costs recently, which has affected many countries. Russia recently has moved closer to financial crisis as a result, while it has been beneficial in some cases.

This might seem like bad news for the oil industry, but actually it could be good in the long term. The cause of the drop in prices is thought to be because of a general oversupply of oil. If companies ease off on production, the value should rise again.

 

What will this cause?

The consequences of this could be incredibly wide-reaching. On the other hand, very little could end up changing. It all depends on the reaction from the ECB. Many economists are calling for the bank to either boost cheap credit or purchase sovereign bonds in order to ease the effects of this deflation.

As reported by MarketWatch, Stephen Pope, managing partner at Spotlight Ideas, said: "This now shines a spotlight of scrutiny on the ECB for every day starting now, up until January 22nd (the day of the next ECB policy-setting meeting). At the press conference on that day, the market will no longer hope or even expect a clear statement on QE. It will demand it."
The eyes of the economic community will be on the ECB in the coming weeks. Hopefully, it will take action to reduce the effect of deflation, or else it could risk causing another financial crisis in Europe.

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