Eurozone heading towards deflation?

 
EUROZONE TOWARDS DEFLATION
 
Since the Inflation rate in the Eurozone fell below the 1% threshold, deflation has been the main debate amongst economists around the world. The European countries which make up the Eurozone have been struggling lately with their creeping GDP, CPI and Unemployment figures. Given the fragility of those economies, it would be good to take a look at 2 key countries which contributes to the Eurozone as a whole.
 
Germany What to say about the European Area's largest economy? This country has been the pillar of the Eurozone for the past years and proved to be the country which pushed Euro's economic data and currencies to the top, even in harsh conditions. Back then, GDP contracted by 0.2%. This was partly a correction after the very high growth in Q1 which was of 0.7%. As a result, quarterly GDP growth averaged 0.4% in the first half of the year, which is close to the country's potential growth rate. In Q2 however, a decline of 0.2% in GDP figures was seen. The main culprits for this slowdown in local production were due to low construction and net export figures. Has Germany started to feel the Eurozone's burden on its shoulder? Not really… the economy is striving to prove its strength to against its local counterparts, even though being let down by the Eurozone as a whole. (With reference to the well-known interest rates) However, we remain optimistic about the German economy, but do not support the fact that it will keep on supporting the Eurozone in the long run, unless ECB takes corrective measures regarding the interest rates. 
 
United KingdomKnown for its stubbornness regarding a single currency area, the UK proved to be one of the most successful economies in the Eurozone. Not later than this week, services PMI from the Queen's area rose to a figure of 60.5, from a previous figure of 58.5. Various data from this country have been positive during Q1 and kept on showing positive results in Q2. Still, if the UK decided to ally currency force with the Eurozone, the Euro might slightly push on the market. Reason why it won't do that? During the financial crisis, UK was as damaged as Ireland, but it had its own central banking system and the pound acted like a shock absorber. It lost value while the central bank chopped interest rates to historic lows, but further took extraordinary measures in order to reflate the English economy. Had it been a Euro member, the damage would have been far, far, far and yeah far worse! UK's economy would have ended up as Ireland with unaffordable bank bailouts, economic bust outs etc… With this, we can exclude its possible alliance with the European currency. However, its contribution to the Eurozone was of 7.366bn last year, which is quite a huge amount for a country which do not use the Euro as currency. 
 
Why deflation threat? Now, let's get back to business and talk about deflation risk. First, economic growth has grinded to a halt in Eurozone's performance for the second quarter of this year. Business services are likely to have strengthened, as the confidence index for this sector strengthened to 3.9 compared with 3.4 in the Q1. Ultimately, tingling in investors mind that manufacturing might have fallen. Moreover, economic activities are held by tight fiscal policies. Many European countries are fighting against severe policies in order to straighten public finance. Monetary conditions on 
its part remained somehow tight despite easing measures by the European Central Bank. However, inflation has severely declined as interest rates remained actively high and affecting mostly mediumsized enterprises.The second half of the year looks challenging, as severe tensions in the Middle East and the Ukraine are likely to weigh on business activity. Moreover, higher energy prices might divert the risk of the Eurozone falling into deflation, but will dent households' purchasing power. Meanwhile, the IFO climate indicator for the Eurozone fell sharply in Q3. Against this backdrop, GDP growth in the Eurozone will struggle to reach 1.2% in 2014, as forecasted three months ago. Some countries may fall behind their budget consolidation programmes. However, it can be doubted that that the European Council will insist on the respecting of the budget targets if the general outlook for the Eurozone is deteriorating, as it would shoot itself in the feet.
Warren Tancredi By: Warren Tancredi
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