Recent market developments have brought the “d” word back into vogue. Talk now is of widespread deflation across the globe. Figures this week have shown UK headline annual inflation running at just 0.1 per cent in July, while in the United States it was only 0.2 per cent last month. Despite the recent fall in oil prices, the devaluation of the Chinese yuan and the drop in emerging market currencies, fears of a world deflationary spiral seem overdone. Domestic forces should continue to be the key drivers of inflation.
Not that long ago it appeared that the threat of widespread deflation had diminished, mainly due to a rebound in global oil prices. However, in the past few weeks, two factors have revived these concerns. First, the prices of commodities in general, and oil in particular, have fallen sharply. And second, China has engineered a depreciation of the yuan. Policymakers fear Beijing’s move could accelerate this “currency war” race to the bottom, particularly as most countries have few growth-boosting policy tools left open to them.
There is no doubt the fall in the price of Brent crude from $67 a barrel back in May to below $50 a barrel now, should lead to lower petrol prices at the pumps, which could drag UK and Euroland headline inflation back into negative territory in the short term. But the recent decline is small compared to the slump in oil prices from over $115 in June last year, and the base effects related to this move should see headline inflation rebounding in late 2015 when the 2014 oil price collapse drops out of the equation. Still, whatever about the US and UK, the euro zone’s inflation rate looks set to remain a long way below the European Central Bank’s target of just under 2 percent because of the high level of spare capacity in the bloc.
Low inflation should be seen as a positive for Irish consumers, boosting disposable income, and pushing up household spending. Indeed, new car sales data for 2015 and retail sales in general would suggest consumers have become more confident and are spending freely. But on the deflation issue, there is another question that needs to be asked. Do most consumers actually believe that overall prices are lower now than this time last year or back in January?
Not so cheap
In my circle of friends, I can’t think of anyone who openly says things are cheaper. Clearly, we can all see the prices at the petrol pumps, and fuel costs coming down. Some food prices may also be lower, but the big ticket items like house and car insurance, university fees and medical costs don’t seem to be decreasing. According to the latest AA annual survey of motoring costs, the 20 per cent rise in insurance premiums for the typical Irish motorist is ensuring they are not saving any money from the fall in fuel prices.
Furthermore, while the consumer price index might show a fall in the cost of home-heating oil, this is of little use to households if they have their heating switched on for longer than normal due to weather conditions, pushing up their energy bills, as has been the case here recently because of the poor summer.
And it’s not just in Ireland. Global central bankers are paying far too much attention to consumer price indices and are, in our opinion, misreading the signals. I recently put that question to a well-known prominent central banker (not from Ireland, I hasten to add) and he looked at me as if I had two heads. But if employers are using the consumer price index to formulate pay increases for their staff, there should be no great surprise that wages have been fairly stagnant. Then again it should be no great surprise either that consumers have been cautious in their spending habits when one looks at the rise in the cost of the likes of motor and home insurance or other big ticket items.
Too much emphasis is put on inflation expectations, whatever they are. Markets and central bankers pay great attention to five-year forward-looking projections, but these are mainly just predictions about oil prices. How many bond dealers have done enough shopping to warrant an intelligent view on consumer prices? Consumers, when asked about future inflation will just repeat the projection of some economist they have seen in the paper. And as we all know, economists were put on this Earth to make weather forecasters look good.
Alan McQuaid is an economist with Merrion Stockbrokers
