The Papers are getting All Steamed Up about Deflation, Says Brian Tora. Maybe Inflation Wasn’t So Bad After All?
While markets seem to have settled down and recovered much of the
ir composure (the FTSE 100 Share Index got within 1% of its all time high of more than 15 years ago since last I shared my views on investment with you), there is still plenty going on that could reinforce volatility in the future. Geo-political issues aside – and there is plenty to cause sleepless nights amongst the trouble spots of the world – we have confusion in the Eurozone, a slowing Chinese economy and a General Election here, the outcome of which is impossible to forecast.
Deflation?
We also have falling inflation. The 0.5% increase in the Consumer Price Index for the end of 2014 – the lowest since this measure was adopted in 2003 – has prompted the Bank of England to revise its guidance on interest rate policy. Having indicated before that half of one per cent was the lowest interest rates could go in this country, Governor Mark Carney stated quite clearly that a further cut could be on the cards as he presented the Bank’s latest quarterly inflation report.
The belief is that inflation is likely to turn negative this spring. Negative inflation – or deflation – is the sort of development that keeps policy makers awake at night. Falling prices encourages consumers and businesses to defer spending plans, with all the knock on effect that has on economic growth. Behind this fall in the inflation rate lays a lower oil price. In part this merely reflects a sluggish global economy, though the decision of OPEC countries to maintain production levels, despite over supply, certainly contributes.
But the fall in the price of oil, with its downward pressure on fuel and energy costs, will drop out of the cost of living equation next autumn. In other words, any period of deflation is likely to be short lived, unless, of course, other factors blow our economic recovery off course and wages do not start to rise in the manner now being promoted by the government. This has been an interesting development. I can’t recall ever hearing a prime minister asking companies to pay their workers more before, but then we are in an election year.
Meanwhile, in America…
Across the pond, recent data on jobs looks like bringing a rate rise from the Fed that little bit closer. It would be ironic indeed if the US were to put interest rates up just as we cut them. Of course, it doesn’t automatically follow that a cut here will take place. Zero or negative interest rates do not have a record of working particularly well. In any event, I would be surprised if inflation in the UK were not up to target sometime next year, though much depends on the outcome of the May 7th election.
It happens that I had cause to trawl through the Office of National Statistics website, seeking data on inflation for an article I was writing for our in-house magazine. What I found reminded me of the wild fluctuations we have seen in the rate at which our cost of living had risen in the past. In the mid 1970s inflation soared above 20%, peaking close to 25%. Just think what that means. If you can’t afford something at the beginning of the year, you will have to pay a quarter more at the end.
Inflation Devalues Debt
But not all the effects of high inflation were bad. House prices fully reflected the rise in the cost of living, but debt was effectively devalued. In short order, many who owned their homes found that the ratio of borrowing to value had improved significantly. Little wonder that governments prefer some inflation to even stable prices. And it is worth remembering that inflation was in double figures as recently as the beginning of the 1990s. Higher inflation could return, though it will need the stimulus of rising economic growth to make it happen.
Being optimistic by nature, I hope – indeed expect – this to happen, so learning of the bearish views of Crispin Odey and Jonathan Ruffer came as a bucket of cold water. Perhaps we are due something of a correction, though I am encouraged by the way buyers emerge on bad days. Still, it takes two to make a market. And as Warren Buffett once said, equity investment is about time, not timing.
Brian Tora is an associate with investment managers, JM Finn & Co
