Although the economy faces countless problems, there’s one it doesn’t have – inflation. Last week’s numbers showed that CPI inflation fell to just 0.2 per cent in August.
Granted, some of this was due to the Eat Out to Help Out scheme cutting the cost of restaurant meals – something that’ll be at least partly reversed next month. Nevertheless, there are good reasons to expect inflation to stay low.
One is the international background. Although oil and other commodity prices have recovered from April’s lows they are still well below pre-pandemic levels.
Another is that wages are falling; last week’s figures showed they were one per cent down from a year ago. Granted, this is mostly because people are working shorter weeks: the average hours of a full-time worker have dropped from 36.9 per week before the pandemic to 30.8 now. Nevertheless, this could hold down prices simply by forcing consumers to become more price-conscious and so resist price rises.
And then of course there’s the fact that unemployment is rising, and likely to do so more when the furlough scheme ends. This will push down inflation both by depressing wage growth and by cutting consumer demand.
Nevertheless, there are some offsetting factors.
Some of these are merely technical. In January, the restoration of VAT on hotels and restaurants will push up inflation. And then next spring, this year’s oil price fall will drop out of the data.
There might, though, be more fundamental upward pressures. One is that firms facing worsened cashflow will be tempted to raise prices to bring in extra cash, in effect trading off future growth for current revenues. Another is that the patterns of demand and supply are changing. Which means that unemployed workers might not bid down wages much simply because they are unable to take the jobs that are available, at least in the short-term.
One big fact, however, tells us not to expect inflation to move very far. It’s simply that, since the early 1990s, it has not been terribly cyclical. At its low point in the 2009 recession it fell to 1.1 per cent – but this was a higher rate than we saw during the better economic times of 2000 or 2015. Indeed, for those of us formed in the 70s and 80s, the salient fact about inflation in the last 25 years has been its stability. This tells us not to expect significant deflation nor a big rise in inflation.
More likely, inflation will stay below its 2 per cent target for a long while.
For savers, this is ambiguous. It’s good news, as it means that our money isn’t being eroded very much by rising prices.
But it has a downside too. With inflation low and likely to remain so, the Bank of England can focus its efforts upon stimulating the economy. That means nominal rates will stay low for a long time. Indeed, futures markets are pricing in negative rates next year and rates of less than 1 per cent until at least 2025. Which probably means that real rates will be negative for many years. If markets are right, then, the pandemic will reinforce the downward trend in rates we’ve seen since the 1990s.
