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Not Very Fabulous News For Europe

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What's going on?

Prices fell 0.2% in Europe in February versus one year earlier – meaning deflation (see our definition) is occurring for the first time since September last year. And that’s not a good sign for the European economy.

What does this mean?

The cheaper price of oil certainly contributed to the drop in prices – that’s, probably, a good thing as it frees up money to be spent on other things. But the problem is that very slow economic growth is also weighing on prices: “core” prices, which strip out the effect of fuel prices, are rising but at a slower pace than they used to (i.e. even excluding oil, prices might be heading towards deflation).

Why should I care?

For markets: This makes it more likely that the European Central Bank (ECB) will take even more aggressive action. Effectively, the ECB could encourage commercial banks (like Deutsche Bank) to lend more money to people and businesses (who will hopefully spend it, thus boosting the economy). Moreover, it could also take action to decrease how much government bonds pay to investors. This would make investors less willing to buy those bonds and, hence, would likely cause the Euro to decline in value as they, say, buy US bonds in US dollars instead. The lower Euro should make it easier for European companies to sell goods abroad – and thus boost the economy.

The bigger picture: Central banks, like the ECB, are becoming less effective. Both the ECB and the Bank of Japan (in particular) have already ramped up their extraordinary measures to boost the economy, but deflation and slow economies persist. New solutions might be needed.

Originally posted as part of the Finimize daily email.

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