Growing euro area deflation risk could hurt German economy

The risk of deflation is growing in the euro area which threatens economic growth in Germany, the Institute of Macroeconomic Research (IMK) said on Thursday. Based on its simulation calculations, IMK expected a stable German economy in 2014 and 2015 but warned of risks such as price stability. The increase in German consumer prices of 0.9 percent in March was significantly below the inflation rate of the European Central Bank of 1.9 percent. In the euro area, prices rose by only 0.5 percent, while prices sank in Greece, Spain, Portugal and Cyprus. IMK in its economic forecast in April said there is a "not negligible probability that inflation remains at a low level or the euro area slips into deflation" because current low inflation rates resulted from under-utilized production capacity and high unemployment. Falling prices may have a negative effect on incentives, consumption and investment projects in the future, the research institute warned. In addition, the real burden of debt would increase, which could overwhelm private and public debtors, especially in crisis-hit countries. IMK forecast German GDP would slow down in 2014 from 1.6 percent to 1.2 percent and in 2015 by 2.4 percent to 1.9 percent because higher real interest rates would raise the price of business investments. To counter the risks, researchers recommended targeted bond purchases in crisis countries. In addition to government bonds, securities of small and medium-sized enterprises should also be considered in order to improve their financial conditions, they added. IMK advocated increasing public investment in economically stronger euro countries, saying it was essential to make infrastructure future-proof, particularly in Germany.