Falling prices fuel fears of deflation for Spain

With Spaniards cautious about spending in an economy suffering a 24 per cent unemployment rate, consumer prices dropped a sharper-than-expected 0.4 per cent in the year to July, Spain's National Statistics Institute said.

The fall in prices in July was the sharpest since October 2009, the institute said, after revising its initial estimate of a 0.3 per cent decline.

In the previous month, Spain's economy, the fourth-largest in the eurozone, had reported an annual inflation rate of zero.

Prices were kept down by the lower cost of entertainment, electricity, tobacco, food and soft drinks, the official statistician said.

When compared to June, consumer prices slumped 1.5 per cent, it said, using figures that are measured in the same way across the European Union.

The Spanish inflation report is likely to be of concern to policymakers trying to safeguard a gradual recovery in activity since the economy emerged in in mid-2013 from a double-dip recession.

Broad, sustained falls in consumer prices can lead people to postpone purchases in the hope of future price declines, a reaction that brakes economic activity. The phenomenon can quickly degenerate into a vicious downward spiral that is notoriously difficult to reverse.

In April, Spain was identified by the IMF as the only country as "high risk" of deflation and called on the European Central Bank to take action.  

The European Central Bank has responded with unprecedented measures to head off deflation, including the introduction of negative interest rates for banks that want to deposit excess reserves with the central bank.

Last week, the ECB held key its interest rates athas a record low level, stimulating economic activity by making it cheaper to borrow money.

ECB president Mario Draghi pledged to keep rates low for an "extended period" in view of the inflation outlook in the single currency bloc.

"Moreover, the governing council is unanimous in its commitment to also using unconventional instruments within its mandate, should it become necessary to further address risks of too prolonged a period of low inflation," he said.