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OPINION

Deflation looms

Deflation looms
August 27, 2015
Deflation looms

Although latest figures from the UK, US and eurozone show that consumer price inflation was slightly positive in July, commodity prices have fallen sharply since then - Brent crude has dropped by $17 per barrel since July 1 and the S&P/GSCI index of commodity prices has fallen 23 per cent - and this could push consumer prices down soon. "There's a good chance we'll see the CPI measure turn negative again" says Martin Beck of the EY Item Club.

Although falling prices might give a temporary boost to economic activity by raising real wages, economists fear they are a symptom of a slowdown in the world economy.

Fathom Consulting's Erik Britton believes the Chinese economy is "in a hard landing": he estimates that real GDP growth is now only around 3 per cent compared to 7.4 per cent last year. There was arguably internal acceptance of this in China as it moved to cut interest rates this week amid continued market falls.

This weakness is spreading. Euro area GDP grew by only 0.3 per cent in the second quarter - less than in the first - with construction activity slumping in June. And a survey by the New York Federal Reserve last week found that manufacturing activity in the region has suffered its worst month since 2009. "The reality is that demand is short around the world" says Alastair Winter at Daniel Stewart. "Trillions of [dollars of] quantitative easing are not working."

One danger is some of China's efforts to combat its slowdown might hurt the west. Mr Britton warns that a "substantial depreciation" of the yuan is possible. That would cut prices in the west by cheapening imports from China and might boost Chinese output at the expense of that in the west.

What's more, the combination of negative inflation and high debt might eventually increase bankruptcies and credit risk; the US saw a big jump in chapter 11 bankruptcies last month, albeit largely due to energy companies.

There are, however, glimmers of hope. This week, the Netherland Bureau for Economic Policy Anlaysis reported a pick-up in world trade, and Germany's Ifo Institute found an improvement in the country's manufacturing output. What's more, there's one reason to believe the fall in commodity prices might not continue much longer. One leading indicator of them is the growth in China's money stock. This has recently accelerated, which might point to stronger Chinese growth and rising demand for commodities in the next few months.