Eight EU states in deflation

By  Ambrose Evans-Pritchard

Sweden has become the first country in northern Europe to slide into serious deflation, prompting a blistering attack on the Riksbank’s monetary policies by the world’s leading deflation expert. 

Swedish consumer prices fell 0.4pc in March from a year earlier, catching the authorities by surprise and leading to calls for immediate action to avert a Japanese-style trap. 

Lars Svensson, the Riksbank’s former deputy governor, said the slide into deflation had been caused by a “very dramatic tightening of monetary policy” over the past four years. He called for rates to be slashed from 0.75pc to -0.25pc to drive down the krona, and advised the bank to prepare for quantitative easing on a “large scale”. 

Prof Svensson said Sweden was at risk of a “liquidity trap” akin to the 1930s, with deflation causing debt burdens to ratchet up in real terms. Swedish household debt is 170pc of disposable income, among Europe’s highest. 

The former Princeton University professor wrote the world’s most widely cited works on deflation, his advice being sought by the US Federal Reserve’s Ben Bernanke during the financial crisis. 

The dispute in Sweden comes as Eurostat data showed that eight EU countries slipped into deflation in March, with Bulgaria at -2pc, Greece -1.5pc, Cyprus -0.9pc, Portugal -0.4pc, Spain and Slovakia -0.2pc, and Croatia -0.1pc. 

The Netherlands is still positive at 0.1pc, but this level is already so low that it is causing debt-deflation trauma for Dutch households struggling to cope with loans near 250pc of disposable income. Dutch house prices have dropped by a fifth. A quarter of mortgages are in negative equity. 

Quantitative easing by the Bank of England has allowed Britain to avoid negative equity on a large scale. UK house prices have fallen in real terms, but the real debt burden has fallen with it. 

Britain’s inflation is now the highest in the EU at 1.6pc but still below target. The UK is one of the few countries left in Europe with an ample safety buffer against an external shock. 

EMU-wide inflation fell to 0.5pc in March, far below the European Central Bank’s (ECB’s) 2pc target. Andrew Roberts, from RBS, said the rate was nearer 0.3pc after stripping out VAT tax rises. The RBS “deflation vulnerability indicator” has risen to 80pc for Spain, 64pc for Ireland, 55pc for the Netherlands and 52pc for Portugal. 

Peter Schaffrik, from RBC, said eurozone inflation was likely to rebound in April since the timing of Easter distorted the data, but warned that there was a “powerful dynamic” holding Europe back. He said the European Central Bank would have to ask whether its staff model was reliable. 

Sweden’s Riksbank admitted in its latest monetary report that something unexpected had gone wrong, perhaps due to a worldwide deflationary impulse. “Low inflation has not been fully explained by normal correlations between developments in companies’ prices and costs for some time now. Companies have found it difficult to pass on their cost increases to consumers. This could, in turn, be because demand has been weaker than normal,” it said. 

The Riksbank has been trying to “lean against the wind” to curb house price rises and consumer credit, pioneering a new policy that gives weight to the dangers of asset bubbles. But this is proving easier said than done without hurting the productive economy, suggesting that it may be better to use mortgage curbs or other means to rein in property mania. 

It is unusual for the Riksbank – the world’s oldest central bank – to be accused of being too hawkish. Swedish economists have been among the most avant-garde for a century. John Maynard Keynes borrowed many of his boldest ideas from the Stockholm School in the 1920s. Sweden largely avoided the Great Depression because the Riksbank tore up the rule book and pursued a reflation strategy very early, with great success. 

The dispute over deflation in the eurozone has become increasingly acrid. Jürgen Stark, the ECB’s former chief economist, accused the International Monetary Fund and others calling for QE of scaremongering. “Warnings about outright deflation and calls for ECB action are misguided and irresponsible,” he wrote. 

The IMF says there is a 20pc risk of deflation in the eurozone. It also warns that chronic “lowflation” of 0.5pc is also corrosive, making it harder for Italy, Portugal and others to claw back competitiveness without suffering a further rise in their debt ratios. Each year of lowflation pushes southern Europe closer to the limits of debt sustainability. /Telegraph