Deflation arrives

Inflation fell below zero for the first time in the post-EMU period in June, probably courtesy of energy related base effects. We expect the inflation rate to remain negative for the next six months or so. But the risk is that the region might enter a more prolonged period of deflation. Indeed, while these energy-related base effects should prove temporary, there are other medium-term factors that will depress core inflation, including falling factory gate prices, rapidly declining wage growth and a big amount of spare capacity in the economy.