As the summer has ground on, and negative interest rates have spread like wildfire around Europe, it is a prediction that has dated rather quickly. European Central Bank (ECB) chief Mario Draghi has once again pulled out his big bazooka, cutting the deposit facility rate further into minus figures and promising more quantitative easing, this time an open-ended programme dubbed ‘QE Infinity’. Meanwhile, the chances of a rate hike at this week’s monetary policy committee meeting is, according to Bloomberg figures, zero; conversely the chances of a rate cut in the much stronger US economy are 100 per cent (in both cases we will know for sure by the time you read this).
For all the talk of monetary normalisation, the reality that has crept up on central bankers is that economic growth is ebbing away. The threat of deflation has quickly become their bête noire – Europe, they worry, is turning Japanese. And as Japan’s example has shown, once this economic phenomenon sets in it is very hard to escape its gravity. The effect is a simple one: in the knowledge that prices might be cheaper in future, consumers and businesses delay spending, and growth suffers further.
The UK is not, of course, in this danger zone right now. And should there be a disorderly Brexit that brings another sterling sell-off, imported inflation may yet prove Mr Carney’s hawkish view correct. Indeed, while the latest consumer price index inflation figure from the Office for National Statistics were lower than expected at1.7 per cent – and the lowest since the referendum – economistssuggest sharply rising wages and the effects of the pound’s latest slide mean this could be short-lived.
That view is further reinforced by a drone attack on Saudi Aramco oil production facilities at the weekend, which saw oil prices spike by a fifth on Monday, the biggest one-day move on record. Although they have since fallen back, the attack has raised the possibility that further disruption to oil supply could reinject inflation into energy prices and, as Alex Newman discusses in this week’s Taking Stock on page 52, suggests that investors have also rather taken their eye off the ball when it comes to geopolitical risks. And perhaps the biggest geopolitical risk comes not from the Middle East but the Far East, and the growing struggle between China and the US – which right now is manifesting itself as a deflationary force.
For investors and savers this adds up to a major dilemma: how to insure against two distinctly different outcomes, inflation and deflation. There is, of course, no simple answer beyond good diversification, patience and nerve – and not falling into the trap of believing you know what the future holds in store.
