According to a July survey conducted by the European Commission (EC), expectations that prices will fall reached their highest level since the commission began tracking comparable data in 1985.

The same survey also showed that excess manufacturing capacity is at its highest point since at least 1990 – another indication that the 16-nation Eurozone region is flirting with a prolonged period of deflation where consumers are reluctant to spend and retailers are forced to keep cutting prices.

Prices in the Eurozone fell 0.1% year-over-year in June. Six Eurozone nations reported negative inflation for the month – Ireland, Portugal, Belgium, Spain, Luxembourg, and Austria. Prices in Ireland fell the furthest, sinking 2.2%, followed by Portugal, where prices fell 1.6%. Belgium, Spain, and Luxembourg all saw price declines of 1%.

Data set to be released tomorrow (Friday) is expected to show that prices slid a further 0.4% in July from a year ago, according to a survey conducted by Reuters.

However, weaker-than-expected price data from Germany released Wednesday could mean an even steeper drop in prices for the region. Consumer prices in the Eurozone’s largest economy fell 0.6% in July from a year earlier.  It’s the first time German inflation turned negative since comparable data was compiled in 1995.

Economists at BNP Paribas said in a research note that they expect Eurozone inflation will fall to –0.6% in July. But the bank also said that it expects the Eurozone’s deflationary period to be short-lived, as the price decline will be exacerbated by low oil prices and seasonal retail discounts.

“The drag on inflation will reach its peak this month, given the favorable comparison with July last year, when oil prices reached their highs,” BNP said.

Still, the International Monetary Fund (IMF) has urged Eurozone policymakers to maintain fiscal stimulus next year and keep interest rates low, as an economic recovery is “highly uncertain.”

“It will be essential to maintain this stance as long as disinflationary pressures persist,” the IMF said.

The European Central Bank’s (ECB) main interest rate currently stands at a record low 1%, but analysts have criticized the bank for not loosening monetary policy quickly enough.

Other central banks “have their own responsibility and decisions and I have already said that as far as we are concerned, we would be very, very keen to avoid to be put in a situation which for us would not be appropriate, namely a liquidity trap,” ECB President Jean-Claude Trichet said last year after the U.S. Federal Reserve announced its decision to cut its benchmark rate to a range of 0%-0.25%.

Source: Eurozone Deflation Becoming a Bigger Concern