Germany, France flirt with deflation

GERMAN and French inflation rates have both slowed to levels which are provoking fears that the main continental economies are now flirting with deflation.

Inflation in both countries is now running close to zero in January and February, leading to fears that a period of deflation could be looming. Deflation is when there is a general decline in prices, which hurts economic activity by discouraging investment.

German prices rose just 0.2 per cent in the year to the end of January, the lowest rate since pan-German records began in 1991. Earlier this week the French also reported inflation of just 0.2 per cent in the year to the end of January. Analysts are divided over whether this will lead to an early interest rate cut from the European Central Bank (ECB). Mr Oliver Mangan, economist at AIB, said the ECB was unlikely to cut interest rates. He said the bank had already noted in the January bulletin that it anticipated the downward pressure on prices and took corrective action when interest rates were cut in December.

He added that, at the moment, the ECB would consider zero inflation to be price stability and the present level of interest rates to be consistent with that as well.

"We are not going to get deflation", he argued. "That becomes a problem when it impacts on people's decisions to postpone expenditure or house buying, which has not happened."

On top of that there was evidence of real economic activity in most countries, with the exception of Germany and Italy. "France, Spain and the Netherlands are all strong," he noted. But other analysts disagree. "This is the writing on the wall that Germany is in deflation territory," Mr David Brown, chief European economist at Bear Stearns in London, said.

"The ECB is holding on to an overly restrictive monetary policy and it has to cut rates and could cut as early as next Thursday's policy meeting."

The German federal statistics office denied Germany was experiencing deflation and indicated that the most recent fall in the euro could lead to higher price increases in coming months.

The office's president, Mr Johann Hahlen, told a news conference that the euro's decline may stop consumer price inflation slipping below zero.

However, the euro rallied a little yesterday as dealers took profits on the dollar and possible euro entry continued to weigh on sterling. The euro closed at $1.1050 from $1.0951 a day earlier and at 68.87p against sterling from 68.57p. As a result, the pound closed up at 87.38p against sterling from 87.06p.

Analysts said the figures were based on a new method which had updated what was in and out with German consumers.

Many of the products added to the consumer price basket reflected a global trend toward communication and technology, such as mobile phones and telecommunications devices. As consumers spent more on a new range of products they also turned their backs on a wide range of goods. Band-aids and cotton dressings for wounds, for example, were both dumped from the Statistics Office's list, as was leaded super-gasoline.