Deflation arrives at last: some clouds and a silver lining

After several months cheaper food and other shop prices have finally-just- prevailed over the bounce-back in oil prices from their plunge in 2014. As I expect oil production to counter any further speculative price rises, inflation is likely to stay negative for several months and remain below 1% until well into 2016 at the earliest. Moreover, the pipeline of continuing negative Producer Input and Output prices will also help to keep the lid on the CPI. So far, so benign!

However, slowing global demand seems to driving prices lower everywhere and it is hard to see that changing soon. Even if the initially reported (and hotly debated) weakness in Q1 GDP is revised higher there is no doubt the US economy is no longer the world’s locomotive while China is struggling to replace it and Japan and Germany have long since given up. Central banks seem to be running out of ideas and there is an increasing disconnect between economic fundamentals and asset prices. There are potentially very dark clouds gathering that could prolong this deflation and make it malign.

Looking on the bright side, the fact that the prices of Services are still rising may provide some silver lining in our Services-dominated economy if they are driven by robust demand for higher value purchases. After all, Central Banks do welcome moderate inflation as a sign of growth and the UK still needs Services to carry the baton for employment during the next few years if and when the economy rebalances. This should keep average earnings moving up and, depending on which services grow the most, might even help (whisper it soft!) productivity.

The immediate implication is that the MPC will continue to sit on its collective hands until well into 2016. The so-called hawks will be outvoted if they propose rate hikes sooner. Equities have remained untroubled throughout the build-up to deflation and now it has arrived gilts and even the pound should also settle down again, the latter reacting more to news and rumours from the FOMC and ECB.

To finish on a slightly pedantic note, the BBC’s Andy Parsons and I  have shared on Twitter our disapproval of describing the latest CPI as ‘low inflation’ or ‘negative inflation’.  We are calling it deflation, for that is what it is and for good reason.

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