Global Deflation Threat Looms Despite Rate Hike

This time last year the Institute for Public Policy Research (IPPR) made a compelling case for keeping interest rates at their historic lows, arguing that although the recovery looked to be on an increasingly sure footing, we were some way off generating inflation through domestic wage pressure, and that if anything, the global growth slowdown meant inflation looked set to fall below 1% in the coming year.

That view now looks prescient, to say the least. Consumer price inflation spent another month at near-zero levels in November, with prices by the CPI measure a mere 0.1% higher on average than a year ago. This makes it a virtual certainty that 2015 will be a year of zero or near-zero consumer price inflation: the first time this will have happened in the CPI’s 27-year history.

This is not just a UK phenomenon: consumer prices have stalled across developed countries, primarily as a result of steep falls in the price of oil over the last 18 months.

Oil price falls feed through to inflation in a relatively simple and predictable way. Initially fuel and energy prices respond, which has the immediate effect of pushing down on both producer and consumer prices. But as reductions in these costs feed through to production, transportation and other input costs, a broader range of goods and services becomes cheaper. This ‘good’ deflation feels much like a tax cut to consumers, and as long as the economy is growing, it is unlikely to turn into a deflationary spiral.

So given that the UK is currently growing at around 2.3%, does this mean deflation shouldn’t concern us as we head into 2016?

It’s worth reminding ourselves why falling prices are such a damaging phenomenon. When a deflation sets in, the real value of debt increases, making it more difficult for borrowers to service their debts. And the UK has a lot of borrowers: the household debt-to-income ratio is currently 135% – lower than the pre-crisis peak (155%) but far above its historical average. Indebted households without asset wealth are particularly vulnerable to deflationary dynamics, since they don’t get the offsetting gains of rising real asset prices: in the UK, 70% of tenants (i.e. those without property investments) hold at least one form of unsecured debt, and around one in eight of them report that their debt repayments are a heavy burden.

via The Guardian

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Alfonso Esparza

Alfonso Esparza

Senior Currency Analyst at Market Pulse
Alfonso Esparza specializes in macro forex strategies for North American and major currency pairs. Upon joining OANDA in 2007, Alfonso Esparza established the MarketPulseFX blog and he has since written extensively about central banks and global economic and political trends. Alfonso has also worked as a professional currency trader focused on North America and emerging markets. He holds a finance degree from the Monterrey Institute of Technology and Higher Education (ITESM) and an MBA with a specialization on financial engineering and marketing from the University of Toronto.
Alfonso Esparza