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Euro zone deflation top risk for world ratings: Fitch

Deflation in the euro zone is a bigger risk to corporate and sovereign credit ratings across the world than the fall in the price of oil, Fitch Ratings reported Monday.

"As the world's second-largest economy, largest importer and largest source of cross-border bank lending, deflation and weakness in the euro zone will have knock-on effects on other regions," said Fitch in its quarterly "Risk Radar" report.

Price reductions in Berlin, Germany
Sean Gallup | Getty Images

Prices in the euro area fell by an annual 0.3 percent in February, slightly less than the 0.6 percent decline seen in January, but nonetheless raising the threat of Japanese-style growth-sapping deflation across the euro zone.

The ratings agency noted that prolonged deflation or falling prices remained a risk in the euro zone, despite the European Central Bank (ECB) launching its quantitative easing (QE) program. This was announced in January and is aimed at boosting inflation.

"QE should help reduce the risk of prolonged deflation in the euro zone through a weaker euro and a boost to confidence. But the ECB's previous easing measures, the introduction of targeted longer-term financing operations and private asset purchases, have so far had a limited impact on credit conditions and dynamics," Fitch said.

Is ECB's QE a success?

Persistent deflation can be dangerous for economies because it deters companies and individuals from spending or borrowing money. It also increases the real value of both the national debt and corporate and households' debt.

Plus, unemployment may rise as a result, because companies sometimes find it easier to make workers redundant than cut wages in line with prices.

Japan's economic stagnation from the 1990s onward is viewed as an illustration of the dangers of failing to tackle falling inflation.

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Fitch added that credit ratings downgrades would only result if the bloc "were heading into a protracted 'Japan-style' deflation, which could lead to self-reinforcing negative debt dynamics, making the downward spiral difficult to reverse."

While Japan's economic stagnation between

This is not Fitch's base case scenario, as it sees rising oil prices to help boost inflation from mid-2015.

Sharp oil fall

Other risks to global ratings cited by Fitch included the 50 percent fall in the price of crude oil seen since June last year. While this has spurred consumer spending in oil-importing developed countries, it has hit the revenues of energy-producing companies and countries.

"The largest financial impact is being felt across a disparate group of energy-producing sovereigns, corporates and public finance issuers whose forecast revenue streams have been cut substantially as oil prices have fallen to around $50 per barrel, " it said.

Fitch also flagged the impact of the emerging market slowdown, which it described as "primarily due to the structural adjustment in China and recession in Russia and Brazil."

It forecast that economic growth in emerging markets would average 3.6 percent in 2015, down from a peak of 6.9 percent in 2010.

"The strong U.S. dollar and higher U.S. interest rates could also expose other emerging-market vulnerabilities, such as high leverage, weak policy frameworks and political fragilities, so the risks for emerging markets are increasing," Fitch said.