Eurozone dips into deflation, but high inflation still a risk

Inflation in the eurozone turned negative in June for the first time since the single currency was set up in 1999, but rising commodity prices are likely to push inflation back up soon across the world, some analysts believe.

Preliminary figures from the European statistics service Eurostat showed -0.1% annualised inflation in June, down from 0% in May. The eurozone joins the US in deflation; the US consumer price index has been falling since March, and the most recent figures showed -1.3% annualised inflation for May. UK inflation remains in positive territory, with CPI inflation at 2.2% in May.

Uncertainty about the pace of economic recovery means there is no clear consensus on inflation, said Ralph Segretti, product manager for inflation-linked and fixed-income index derivatives at Barclays Capital in London: "There's really a divergent outlook on inflation, even inside this bank. There are cases for both sides."

The bank's chief European economist, Julian Callow, pointed to three signs of a coming rise in inflation: output is rising strongly in Asian economies; the US Federal Reserve is "probably about halfway" through its asset-purchase programme, with significant securities purchases still to come; and commodity prices, especially energy prices, are rising. But he warned quantitative easing programmes might not have immediate effects on the wider economy.

"In Japan, quantitative easing was not a success," he said. "The weak financial sector meant the money multiplier effect was not working. In the US, the Fed can increase the money supply through bank deposits, but these deposits are idle; banks are not lending them out because demand for loans is low, so the expansion in the money base is dormant."

Barclays' head of inflation research Alan James added that "indirect taxation is also an inflationary risk", pointing to the impending reintroduction of 17.5% value-added tax in the UK and a possible federal sales tax in the US, but added that breakeven rates contained a significant risk premium, due to the volatility and uncertainty of future inflation rates, and so were higher than actual expected rates.

Increased supply of inflation-linked bonds, a likely outcome as governments raise more debt as part of stimulus programmes, could also drive up yields. This has yet to happen in the UK, however, where real yields are at an all-time low despite issuance almost doubling, he added.

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