With deflationary pressures returning to the Eurozone policy makers on both sides of the Atlantic are coming under increasing pressure to respond with a fresh round of quantitative easing (QE).

Former Fed Official, James Bullard, was the first to hint the Federal Reserve may increase QE rather than taper to fight deflation and an economic slowdown in the Eurozone. Analysts are concerned a lack of liquidity is increasing the chances of another economic crisis.

Worryingly, French, Italian, Irish and Portuguese bonds yields have started to diverge when compared to Germany’s. This dynamic suggests traders are concerned deflationary pressures are increasing the chances of sovereign debt default in the periphery. Deflation increases the real value of debt making it harder for debtors to repay. Deflation also discourages consumer spending by customer delaying purchases in the belief goods will be cheaper in the future.

Research by Professor Richard Werner indicates that Spain, Italy, Slovenia, Greece and Slovakia are already in deflation in September. Worryingly, Werner believes inflation in Italy has collapsed to a rate of minus 5% over the last 6 months.

Deflation is the Central Banks worst nightmare as most believe it was the cause of the great recession off the 1920’s.

As a result Central Banks have stated they will do everything they can to head off deflation, but with interest rates at near zero they are running out of options. The recent stock market sell off will only increase the pressure on Central Banks to act.