Euro Zone Faces Threat of Too Little Inflation

Consumer prices in the euro zone are rising at the slowest pace since the depths of the global financial crisis, fueling new fears that too little inflation, rather than too much, will threaten Europe’s fragile recovery and the world’s.

October’s annual inflation rate pulled back sharply to 0.7% from 1.1% in September, the European Union’s statistics office said Thursday, marking the lowest level in four years. That is far below the European Central Bank’s target of just under 2%, putting pressure on it to reduce interest rates as soon as next week’s policy meeting.

The latest numbers signal that dangerously low inflation—which Japan struggled with for two decades and the U.S. central bank has labored in recent years to avoid—is at Europe’s front door.

The drop “has been pretty fast and is unlikely to be reversed,” said Lorenzo Bini Smaghi, a former executive board member at the ECB.

“On top of low inflation you have a euro that is relatively strong and you have a credit crunch,” he said, referring to recent declines in bank lending to businesses in much of Europe.

When inflation is close to zero, companies, households and even governments have a harder time cutting their debt loads. Profits are squeezed—threatening investment and jobs—and consumers may hold off on big-ticket purchases.

The pressure intensifies if prices drop on a sustained basis, a situation known as deflation that Europe wants to avoid.

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