Eurozone July CPI Drops At Fastest Pace On Record

Eurozone consumer prices declined at the fastest pace on record in July. However, the slower-than-expected economic contraction in the second quarter allayed fears of deflation and suggests that inflation will soon turn positive in the single currency bloc.

Friday, the European Union statistics office Eurostat revised the annual decline in consumer prices for July to 0.7% from the flash estimate of 0.6%. This was the second consecutive month of decrease and the biggest fall on record. Prices were down 0.1% in June. Month-on-month, consumer prices dipped 0.7% in July.

The European Central Bank aims at inflation rates below, but close to 2% over the medium term.

Stripping out volatile items like energy, food, alcohol and tobacco, core inflation was 1.3%, slightly slower than June’s 1.4%. The rate matched economists’ expectations.

Alcohol and tobacco prices gained 4.4% annually, while household equipment costs moved up 1.7%. On the other hand, energy prices plunged 14.4%. Transport and housing costs were down 5.5% and 1.8%, respectively. Also, food prices dropped 1%.

In the meantime, EU27 recorded an annual inflation rate of 0.2% in July versus 0.6% in June. A year ago, the rate was 4.4%, the Luxembourg-based Eurostat said.

Among the EU member states, the lowest annual rates were observed in Ireland, Belgium and Luxembourg. By contrast, Romania, Hungary and Poland reported the highest inflation rates. Compared to June, annual inflation dropped in twenty member states, stayed stable in one and increased only in five nations.

The Eurozone economy contracted 0.1% in the second quarter even as Germany and France emerged out of recession, indicating an early recovery from a deep recession. The second quarter contraction was much slower than the 2.5% decline seen in the first quarter.

Dresdner Kleinwort economist Rainer Guntermann expects inflation to stay negative until the final quarter of the year. Further, the fundamental outlook suggests no concrete inflationary or deflationary tendencies in Eurozone, the economist said.

The economist envisages an average rise in consumer prices next year of just below 1%, which will still be lower than the ECB target. Despite low interest rates and quantitative easing, long-term inflation expectations should stay close to the central bank target.

Unemployment is still increasing, which is keeping wage growth on check. The expected growth in the second half of the year would not be strong enough to allow companies greater leeway in raising prices. Guntermann said core inflation would settle down at just below 1% in 2010. The fundamental scenario does not suggest any concrete threat to deflation either. The central bank is expected to leave its interest rate at 1% until the third quarter of 2010.

On August 6, the ECB had retained its key rate, which is the interest rate on the main refinancing operations, untouched at a record low of 1%. The bank has lowered the key interest rate by a total of three and a quarter percentage points since early October 2008.