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Euro-Zone Deflation Threatens Retail Industry

As Europe continues to experience historically low inflation, the retail industry is scrambling to anticipate the impact stagnation, or even deflation, will have on business.

On March 31, euro-zone inflation dropped even further to 0.5%, its lowest ebb in four years, and considerably lower than the general target of 2 percent. Now attention has turned to the European Central Bank’s (ECB) forthcoming response and the potential impact it will have on commerce. The ECB has consistently hinted that it remains prepared for imminent action should inflation dip perilously low, and has publicly entertained the possibility of floating long-term loans to banks and massive asset purchases.

However, many experts are frustrated by the ECB’s hesitancy. Dirk Schumacher, economist at Goldman Sachs, said, “At some point, actions speak louder than words.” At the very least, Schumacher predicts that the ECB will cut the primary lending rate from 0.25% to 0.10%, and also reduce the rate for overnight deposits at the ECB all the way down to -0.15%, currently at zero. Schumacher said, “If they don’t do anything despite this low inflation print, there’s a risk that they would lose some credibility.”

For the most part, the recent decline in the inflation rate is the consequence of unseasonably warm weather that diminished food and energy prices, and the lateness of Easter this calendar year, which postponed increased holiday sales well into April. Energy prices alone plummeted 2.1% in March. Additionally, prices for products and services fueled only by domestic consumption rose at a pace well below the targeted inflation rate: 0.8%.

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The big currency concern in the E.U. since 2013 has been the gathering threat of deflation. Consumer price inflation in the seventeen countries that use the euro held at 0.8% in the last month of 2013, well below the E.U.’s target rate of approximately 2 percent. The fear is that wages and savings will simultaneously suffer from devaluation, ultimately strangling demand.

The stakes for the retail industry promise to be considerable. If prices grow at a crawl, the constellation of stakeholders–the government, business and consumers–respond by tightening their belts since it becomes harder for them to service their debts, now increased in value. For consumers, the allure of lower prices is offset by the fear of their contracting savings–the predictable tendency is that they respond to deflation with collective wariness, putting off unnecessary expenditures until prices stabilize.

Mario Draghi, ECB President, pledged to act quickly if an urgent need presented itself. “We will do what is needed to maintain price stability.” Despite criticisms that it is slow to act, the ECB has a history of sudden, unpredictable responses. Last November, it dropped the main lending rate to 0.25% immediately after inflation dipped from 1.1% to 0.7%.

It’s important to note that, even though the euro-zone shares a common currency, its defining feature, different countries can disparately experience deflation. Spain has suffered from lower rates of inflation in March than its neighbors, and Italy’s inflation has descended to 0.3%.