by Simon Bond

Unemployment coupled with deflation left unchecked are a twin scenario that makes monetary authorities around the globe more frightened than you can possibly imagine. What do you think politicians see in a world where more than half of their region's 16 to 25-years-olds are unable to find meaningful jobs.

In a world of deflation, financial logic gets turned upside down, and nasty things happen. Consumers put off purchases in anticipation of getting a cheaper deal later on. The value of outstanding debts, such as mortgages and car loans, gets bigger every year. And governments and central banks find it a mighty struggle to revive the economy.

That, in a nutshell, is what has happened to Japan, once a powerhouse of the world economy, during the past 20 years. And it’s the danger that the European Union is facing after five years of self-imposed recession and stagnation. In the year to August, prices rose by just 0.3 per cent on an annual basis, and the inflation rate keeps going down. With the rate of unemployment still well above ten per cent (in July, the rate was 11.5 per cent), negative inflation – falling prices – is a real possibility.

Recent economic news from Europe in my view sends a message that authorities believe that there is a clear and present danger of deflation across the entire area. If left unchecked the damage spreads from economics, to politics to social problems, the list goes on.

Although Germany's inflation rate in August was twice the eurozone average, a stagnant economy and falling confidence are raising the risk of deflation. Marcel Fratzscher, who heads the influential German economic-think-tank DIW, was quoted by the Financial Times as follows: “Deflation does not come all at once. It comes company by company, and sector by sector. I definitely see a risk of deflation in Germany."

I personally expect that Mario and the gang will hit the market, and hit it hard with new and enlarged strategies to thwart the prospects of a spiral into the unknown. Expect the unexpected and this should ensure that interest rates remain lower for longer than anyone currently expects.