By Martinne Geller
LONDON (Reuters) - Weak consumer spending and intense competition among retailers are forcing some makers of packaged goods to lower their prices, intensifying the threat of euro zone deflation.
Annual inflation is running at just 0.5 percent in the currency area, well into what the European Central Bank has described as a "danger zone" below 1 percent, and could fall further when figures for July are released later this week.
The ECB has said it sees no signs that financial markets or consumers expect a prolonged period of prices falling across the economy – as Japan experienced in its "lost decade" when people deferred spending in the knowledge that goods and services would get cheaper – thereby creating a downward economic spiral.
Yet some signs of deflation are already evident in corporate earnings results, as retailers and consumer goods manufacturers struggle with consumers' reluctance to spend freely.
The evidence points, at the very least, to a prolonged period of what economists have called "lowflation", which would be likely to curb economic recovery.
"Spending is much more targeted, more thought-through," said Ed Hudson, consumer products leader in Britain for professional services firm EY. "It is very hard for the consumer packaged goods companies to put up prices, or indeed offer great big volume discounts."
Unilever (L:ULVR), maker of Dove soap and Ben & Jerry's ice cream, reported a 1.9 percent fall in its European pricing in the second quarter ended on June 30, as declines in Germany, France and the Netherlands offset increases in the recovering markets of Spain, Italy and Greece.
"There are two stories taking place in Europe," said Unilever Chief Financial Officer Jean-Marc Huet, referring to how the southern countries - which were harder-hit by the euro zone crisis than northern neighbours - were now seeing some rebound.
That fits with recent signs of economic recovery in Spain and even Greece, albeit from a very low base, while the French economy is flatlining, the Netherlands contracted in the first quarter and the Bundesbank forecasts the dominant German economy achieved no growth in the second three months of the year.
"The macroeconomic environment, the discounters and promotional competitive activities have not been helpful," Huet said. Unilever's overall prices rose 1.9 percent in the first half thanks to pricing power in emerging markets.
Rival Nestle (VX:NESN) has seen the same. When the world's largest food group posted first-quarter results in April, it said overall pricing rose 1.6 percent, but fell in Europe. Nestle will report half-year results on Aug. 7.
DISCOUNTER EFFECT
Companies such as Nestle and Unilever have been pressured by the success of discount retailers Aldi [ALDIEI.UL] and Lidl [LIDUK.UL], which have also eroded sales and profits for retail rivals including Spain's Dia (MC:DIDA).
Dia, spun off from France's Carrefour in 2011, reported a 5.6 percent drop in like-for-like quarterly sales in Spain and Portugal on Monday, due to price competition despite a fledgling economic recovery.
Ricardo Curras, chief executive of Dia, said he expects deflation to continue into the third quarter, with some improvement in the last quarter.
In Britain, struggling Tesco (L:TSCO) and Wm Morrison (L:MRW) are trying to revive sales by cutting prices, while in France, Casino's (PA:CASP) first-half trading profit was hit by price cuts, particularly at its Leader Price discount stores.
After a poor second quarter, there are some signs of a rebound in euro zone activity.
In July, the euro zone's services sector expanded at its fastest pace since May 2011 but higher growth in new business was driven mainly by companies cutting prices, according to the Markit Composite Purchasing Managers' Index (PMI).
Euro zone service firms have now cut prices for 31 months despite high raw material costs, meaning profits are squeezed unless they can reduce costs elsewhere.
"Generally the European market is still in the deflationary stage for most household and consumer staples goods," said Fintan Ryan, an analyst with Berenberg Bank.
(Additional reporting by Sumanta Dey in Bangalore and Sarah Morris in Madrid; editing by David Stamp)