All change as deflation threatens

Normally I write about ideas that might help save money, but sometimes the economic world is so removed from the norm that it is hard to resist trying to make some sense of what’s happening. For years we worried about inflation; not very long ago people found it impossible to protect savings from it. At the same time inflation was eating away the real value of debt. Now concern has switched to a lack of inflation, or, in the eurozone, deflation.

This is now a problem in the G7 group of the world’s major economies. It has been driven partly by the big drop in oil prices – over 40% in the past six months – because energy accounts for up to 10% of inflation. However in a weak economy, such as the eurozone, there are more fundamental problems. Even without the impact of lower energy costs growth is so poor that inflation is hovering around zero. That creates a downward spiral. No growth means no confidence, so people do not spend; their debts are no longer absorbed by inflation and there is a view, when it comes to expensive items, that it’s better not to buy because prices will fall further.

Conditions like this are the real enemy of economic growth, and for the eurozone deflation is both a symptom and a cause of economic problems. Confidence in the currency has evaporated, highlighting its core problems. That has led to poor economic growth, even in Germany which has its lowest inflation rate for 50 years. That is adding to a lack of consumer confidence, driving down spending and turning inflation to deflation.

The eurozone is in a uniquely bad situation. For other economies low rates of inflation are less serious. That includes the UK, even if the Bank of England is now concerned that the rate is well below the Government’s target of 2%. This can be largely explained by lower energy prices, intense retailer competition and lower commodity prices driving down food prices for the first time in many years.

The underlying UK economy is strong and growing, albeit at a slightly lower rate than expected. That’s why sterling is strong against a weak euro. This is a situation likely to continue, which is not necessarily good news for farming. It traditionally does well in a weak currency situation which boosts exports and discourages imports. However if you are a borrower, as most businesses are, the low inflation rate is heading off the pressure from rising employment and wages for a rise in interest rates.

Concerns about low inflation are in many ways uncharted waters. For the eurozone the problems are deep and fundamental, and just as the US and UK are winding back funds used for quantitative easing – money printing – there are signs that the European Central Bank will be forced to introduce it for the eurozone to stave off deflation. If that happens it will be expensive, and may prove too little, too late.

For the other G7 nations inflation rates range from zero in Italy to 1.7% in Canada. This is the first time collective rates have been below 2% since 1932, and the Great Depression. This adds to a sense that the end of the recession has triggered new financial circumstances that are as challenging as anything that went before, certainly since the start of the recession in 2007, and worse for the eurozone than anywhere else.

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