Latest figures show that consumer price inflation in the eurozone has fallen to a four-year low of 0.7 per cent - with prices falling in Greece and Ireland and flat in Spain and Portugal - while it is close to a four-year low in the US. Even in the UK, the inflation rate, excluding energy and food, is just 1.9 per cent - also a four-year low.
These low rates reflect the fact that mass unemployment is holding down wage costs, while spare capacity is forcing down commodity prices; the S&P GSCI measure has fallen 9 per cent since February.
With inflation so low, economists expect central banks to stick with their cheap money policies. Ethan Harris at Bank of America Merrill Lynch expects only a "slow, careful" withdrawal of quantitative easing in the US, which, he says, should "allow an ongoing equity rally". Philip Shaw at Investec doesn't expect the Bank of England to raise rates until the summer of 2015. And, in the eurozone, the European Central Bank's chief economist, Peter Praet, recently suggested that the ECB could begin quantitative easing or even introduce negative interest rates, charging banks to deposit money at that ECB.
Although falling inflation raises the possibility of outright deflation - Marchel Alexandrovich at Jefferies Fixed Income estimates that over one-fifth of prices in the euro area are already falling year-on-year - most economists are unworried by this. They expect economic growth to reduce the amount of spare capacity and so stop prices falling. Eric Chaney at Axa Investment Managers expects inflation to rise slightly next year in the US and the euro area, to 1.8 and 1.5 per cent, respectively. "Deflation is unlikely to become entrenched," he says.
But even if deflation does happen, says Barclays' Kevin Gardiner, it "might not be a big deal". He says that deflation needn't squeeze profits as long as wage costs stay low, while the impact of deflation in raising real interest rates could be mitigated by central banks imposing negative nominal rates. Deflation, he says, "is a symptom, not a cause, of stagnation", adding that it needn't overturn his preference for shares rather than bonds over the longer term.
