Europe is deflated, investors are encouraged

Figures out today showed the Eurozone has officially slipped into deflation, with prices declining 0.2% in December compared with the same month a year earlier.

The upshot was that European stock markets all recorded strong gains and the FTSE 100 also saw its first gain of the year, as investors speculated that the European Central Bank (ECB) will now be forced to introduce full-blown quantitative easing (QE) in an effort to boost the region’s faltering economy.

The threat of deflation has been hanging over the Eurozone for months and investors have been  looking to the ECB to take action to stimulate the economy. Many City analysts are now predicting that the ECB will overcome the objections of Germany and decide to buy sovereign debt at its next meeting on 22 January 2015.

The prospect of QE certainly encouraged investors who have been concerned both by the possibility of a Greek exit from the Eurozone and by the falling oil price.

Despite dropping below the $50 per barrel mark for the first time since 2009 earlier today, Brent crude rallied back above $51. The rebound helped to boost London-listed oil shares, which have a significant weighting in the FTSE 100.

The Eurozone inflation figures follow on from German data on Monday that showed Germany had experienced inflation of just 0.1% in December, down from 0.5% in the previous month.

Whilst we worry about inflation, deflation is a problem because consumers and businesses tend to hold off making purchases, believing they will be cheaper in the months ahead. This can have a negative impact on output and jobs, hence sowing the seeds of recession.

A purchasing managers’ index (PMI) for December was published yesterday and this showed continued weak growth in the Eurozone, with a score of 51.4. A score of 50 or above indicates growth, but Markit, who compile the survey, said the reading suggested expansion of just 0.1% in the final quarter of 2014.

Full-blown QE, coupled with the weakness of the euro and falling all prices should benefit most European firms. Many are diversifying geographically and now generate a significant proportion of their earnings from outside Europe, whilst some of the world’s most recognised brands are owned by European companies. Despite the gloomy outlook, there could still be investment opportunities in Europe in 2015.

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