Lost coins only make everyone else’s coins worth slightly more. Think of it as a donation to everyone.
As the number of people using Bitcoin grows, the number of lost coins will also grow. But Bitcoin can still function with a reduced supply. The coins are divisible to 8 decimal places. There is nothing wrong with a deflationary currency.
I think the traditional notion that deflation is harmful comes from the experience of fiat currencies where a central bank can print money. With Bitcoin, the supply is fixed and known in advance, so the usual arguments about deflation don’t necessarily apply.