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IN YOUR INTEREST
C
hristine Lagarde, the International Monetary Fund’s
managing director, called it an‘ogre stalking the
world economy’. Bank of England (BoE) Governor
Mark Carney said it would be‘unambiguously
good’ for the UK, at least for a time.Whoever is
right, and they may both be, de ation has been moving closer to
reality for the British economy.
In ation, as measured by the Consumer Prices Index, fell from
0.5% in December to 0.3% in January, and then further to 0% in
February
1
.This was its lowest level since comparable records began
in 1989.The biggest in uences were falling fuel and food prices.The
BoE’s target level is 2%. Since the outcome missed the target by a
margin of more than 1%, Governor Carney was obliged to write a
letter to the Chancellor of the Exchequer, explaining why.
The letter wasn’t his rst, and it won’t be his last. Most economists
now think that in ation will dip below zero, thereby becoming
de ation, for at least a brief period.The last time that happened here,
albeit using a di erent measure, was in 1960.We should
all hope it is short-lived, as classic and prolonged
de ation can be an ugly phenomenon.
Carney certainly expects in ation to fall
further. He said it would‘potentially turn
negative in the spring and be close to zero
for the rest of the year’. But while de ation
is a bogeyman for most economists, he has
been relatively upbeat about the prospect.
‘The combination of rising wages and
falling energy and food prices will help
household nances and boost the growth
of real take-home pay this year to its fastest
rate in a decade,’ he told reporters.‘This will
support solid growth in consumer spending.’ He
sent an unambiguous message that the next move in
the interest rate, that has been at 0.5% since March 2009,
would be upwards, although a move is not imminent.
We have all been enjoying cheaper petrol, the result of signi cantly
lower prices in the international oil market.This has fed through into
lower costs for manufactured goods, food and imports in general.
Supermarket competition has been driving food prices down further.
If we are feeling the pinch less, we may be more inclined to spend on
other things, as Carney suggested.
But falling prices become more pernicious over a sustained
period. People postpone buying goods, particularly big-ticket items,
because they know they will be cheaper tomorrow. Companies are
forced to cut prices, so they put o investment and recruitment.
Unemployment rises.With wages stagnating, consumers spend
even less. Government tax receipts su er. Debt becomes even more
burdensome, because every pound that is repaid is worth more than
the pound that was borrowed.That applies equally to individuals,
companies and governments.
This pattern is what was seen in Japan in the late 1990s, after that
country’s prolonged boom had turned to bust. Its economy has been
in a state of de ation and has su ered stagnation for most of the
time since then.With the help of Prime Minister ShinzoAbe and his
‘Abenomics’ policies, however, in ation and growth have recently
returned to the Japanese economy.
Prolonged de ation changes the game for investors. In equities,
they need to be more selective. Companies will nd it much harder
to grow, so big blue-chip stocks with pricing power and resilience
will become even more attractive.Those in defensive industries or
monopoly markets will be in demand, as will the willingness and
capacity to keep paying dividends. Investors will also be looking for
high-growth smaller businesses that are more nimble and innovative
than their bigger brethren.
De ation enhances the attraction of xed-rate bonds as the
real return, which is adjusted for in ation, becomes more valuable;
so yields on triple-A sovereigns and high-quality corporate bonds
could shrink even further.
The fact that de ation causes asset prices to fall and debts to become
more onerous means it can detract from investment in property.That
would typically involve committing to long-term debt, to
be paid o in increasingly valuable pounds, for an asset
whose own value will depreciate – not only buy
to let, but commercial property, too. In the
same spirit, if a de ationary environment is a
bad time to borrow over the long term, it’s
a good time to pay o your debts.The fact
remains, however, that de ation is usually
more talked about than real.The IMF’s
Lagarde is correct to describe it as an ogre,
but BoE Governor Carney is probably also
on the mark when he says it won’t be around
long enough to do any harm.
Remember that in ation and de ation
describe the movement of prices over a period
of time.The biggest driver behind the present fall
in in ation has been the drop in oil prices. But they are
unlikely to fall much further, if at all, and have in fact recovered
slightly from their January lows. So while the price of oil may remain
low, its de ationary power may be all but spent.
The last major de ation was during the Great Depression of the
1930s.Then the US Federal Reserve made the (de ationary) mistake
of limiting the money supply.Today, the world’s central bankers have
headed in the opposite direction with quantitative easing which, since
it is e ectively printing money, is in ationary.
Pavilion Global Markets, a Canadian rm, recently updated an
earlier IMF study into just how prone major economies were to
de ation.The answer was less than they were in 2003, or even in
2009
2
.‘In the world,’ its authors concluded,‘the risk of de ation
is considered low.’
1 Office for National Statistics
2
Balance sheet
With the UK economy flirting with deflation, Bank of England
Governor Mark Carney appears relatively upbeat about the prospect. But what
happens when a country’s deflationary period lasts longer than expected?
If we are feeling the
pinch less, we may be
more inclined to spend
on other things
THE INVESTOR
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