Andrew Miller: Could aggregate consumer prices actually fall?

The spectre of deflation is said to be hanging over Europe. Developed world inflation has slowed, and by more than was expected in 2013, reflecting lower commodity prices and still-slack (although growing) economies

Andrew Miller
Andrew Miller

The spectre of deflation is said to be hanging over Europe.

Developed world inflation has slowed, and by more than was expected in 2013, reflecting lower commodity prices and still-slack (although growing) economies.

This has been most visible recently in Europe (including, unusually in this context, the UK).

The most visible exception has been Japan, where prices have risen. The emerging world has also been immune.

Could aggregate consumer prices actually fall? Of course, however, we do not yet expect them to.

At less than 1% in the eurozone, recent inflation is almost indistinguishable from zero to start with. G7 consumer prices fell in 2009.

Economies were much slacker then, but a renewed decline is still possible. The world would not suddenly stop turning if that were to occur.

The worry is that falling prices and wages add to the burden posed by debt, and encourage households and companies to defer spending (in order to buy more cheaply later).

In practice, however, real interest rates are so low to start with that modest deflation may be lost in the wash. In an emergency, nominal interest rates could even turn negative – the textbook idea that they couldn’t is mistaken (think of it as paying to store money, just as you pay to store furniture).

And small movements in the CPI may not be that visible to typical consumers and businesses, as noted.

This applies even in Japan, where the CPI fell by a cumulative 8% only over 14 years.

Deflation there may be a symptom, not cause, of stagnation: Japan is not conventionally capitalist, and its lessons for us are unclear – but we digress.

Even corporate profits may be less exposed than feared. If unit costs fall with prices, margins might even rise.

And if deflation partly reflects oil prices, consumers’ spending power may get a lift, although the direct effect on aggregate profits, contrary to received wisdom, would be to reduce them (there are more big oil suppliers than users in most big stock markets).

Of course, a big fall in consumer prices – a 5-10% decline, say – would be different. But historically, such a fall has most visibly occurred as a consequence of the Great Depression – and if there is a depression lurking round the corner we’ll have enough to worry about.

Conclusion? A fall in consumer prices needn’t materially change the medium-term investment outlook.

Our strategic preference for stocks over bonds might not be much affected; bonds likely face real, not just nominal, interest rate risk in the years ahead.

Within fixed income, linkers would of course look less appealing, but many of those have long looked dear, and are not always bought as investments to begin with.

:: Andrew Miller is a director of Barclays Wealth and Investment Management in Newcastle

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