Inflation is good...the alternatives are not!

The UK has seen inflation rates gradually falling in recent times, with recent falls appearing to accelerate. There is no guarantee that this trend will continue, but with current inflation rates standing at 2.3% RPI (Retail Prices Index) and 1.2% CPI (Consumer Prices Index) in the year to September 2014 (source: Office for National Statistics), the possibility of stagflation, and even deflation, and their consequences, need to be revisited. 

As you will see, inflation, believe it or not, can have its benefits.

Stagflation

The term 'stagflation' refers to a combination of ‘stagnation’ and ‘inflation’. Stagflation is an economic phenomenon characterised by slow economic growth and rising prices. The term was first coined in the 1960s in the UK to describe the combination of a stagnant economy, increasing unemployment and rapidly rising inflation owing to dramatic upward movements in world oil prices. Stagflation hit the UK hard in the 1970s, as rising inflation and lack of employment opportunities stifled economic growth. 

There are a range of theories about why stagflation occurs. Keynesian economists cite supply shocks as the cause, for example rapidly rising oil or food costs. Others blame excessive growth in the supply of money – as Milton Friedman described, “too much money chasing too few goods”. It has also been argued that stagflation is just a natural part of the modern economic cycle or that political and social structures are responsible for the phenomenon.

Whatever the cause, stagflation raises serious dilemmas for economic policy because actions designed to reduce unemployment may exacerbate inflation, and vice versa.

Deflation

Deflation is the opposite of inflation - a general decline in the price of goods and services. It occurs when the inflation rate becomes negative, i.e. when the inflation rate falls below 0%. Deflation is often caused by a reduction in the money or credit supply, although it can also be caused by a decrease in spending by the state, the consumer or the financial community. Deflation increases the real value of money over time. This is because consumers will hold back on purchases of goods and services with the expectation that the price of these will fall over time. This fall in demand, combined with an increase in the real value of debt, leads to increased unemployment, which in turn can lead to economic depression, as seen in the US between 1930 and 1933 when the rate of deflation was rapid, banks failed and unemployment peaked at 25% of the population. 

Japan: 20 years of deflation

Japan has experienced deflation and its effects since the mid-1990s. The initial shock came in the early 1990s with the bursting of the economic ‘bubble’ of super-inflated property and stock market prices. The subsequent collapse lasted for more than a decade, as the slump in demand caused by the bursting of the asset bubble resulted in Japanese firms being unable to raise sales prices and cutting wages and employment as a consequence. From the late 1990s onwards, wages began to fall faster than prices and deflation became entrenched. With no incentive for firms to invest, the economy became trapped in deflation, with falling prices, falling wages and falling investment combining to maintain the downward pressure.

Is there a lesson here for Europe and the UK?

Firms in the Eurozone are responding to the lack of demand and their inability to impose price rises with a conviction that cutting labour costs is the route back to competitiveness. This is worryingly reminiscent of the vicious circle in which Japan became trapped in the 1990s and the threat of deflation is therefore of real concern to Eurozone leaders.

Summary

It will be interesting to see how the next few months pan out for the UK economy and the way that the Bank of England uses its financial tools to control, where possible, the outcomes. Inflation, against its alternatives noted above, can have its ‘benefits’. With many now suggesting that Bank Base Rates (currently 0.5% pa) will stay at this level until summer 2015, the effect of inflation or stagflation….or worse, could have a real effect on the value of the money we have to spend over time.

No individual pension/ financial advice is provided during the course of this blog.

If you would like guidance and advice on your income planning for the future then please contact the team at Chapters Financial at either our Guildford (01483 578800) or Woking (01483 330800) offices.

Keith Churchouse BA Hons FPFS
Director, Chapters Financial Limited
Chartered Financial Planner
Certified Financial Planner
ISO22222 Personal Financial Planner

Chapters Financial Limited is authorised and regulated by the Financial Conduct Authority, number 402899.

2014....here we come!

The only certainty that can be offered by future predictions is that they will be wrong. At this time of year many pundits and alike prepare thoughts for the future year and I have penned some of my own generic views for the future year. It should also be clear that financial planning should usually be considered to be a medium to longer term view and looking at one year, future or past, may be of limited overall benefit. However, in conjunction with the medium to longer term view mentioned above may add value.

One of the main targets for financial predictions in the UK is the FTSE 100 index and its end value at 31 December 2014. Ending at 6749 at the end of 2013, my view is that it will continue to climb to 7550 points. I appreciate that this is a little over 10% increase, however I still believe that both the US and UK Equity markets have mileage in them (mainly led by the US market) and I think we will see this come through over the course of 2014. Dividend returns I believe will remain strong and this may be of interest to savers who are suffering from low Bank of England base rates and deposit returns.

It is of note that there is a disparity between the two markets, in that the US main indices, the Dow Jones, broke its previous ceiling in 2013. The UK market has yet to do this, but is indicating its emergence to a growth phase. I think that this anticipated growth will not be without its volatility, again mainly led by the US, with tapering of its easing mechanisms and also the political malaise of the debt ceiling. Volatility is a natural companion of all stock markets, and we may also see volatility (possibly positive) in the underlying currencies of Sterling and the Dollar.

Europe may also show some signs of recovery, however, I still believe that the inherent issues surrounding the Euro and the Eurozone will weigh heavily against the constituent countries and its industries.

The UK also has a General Election at the latest in May 2015. From this perspective, there is likely to be an objective to create a 'feel good' factor (as far as this can be achieved or measured), by the current administration, to promote success at the polls in around 16 months’ time. Whether this can be achieved, based on the limited slack in the current UK budget, remains to be seen.

As one final word of warning, anyone who knows me will know that I am ever the optimist, this being indicated in my last book, The Recession is Over, Time to Grow, published in June 2013. I can be wrong, as any other person offering a prediction.

Past Performance is not a guarantee of future performance and indices can fall as well as rise.

If you would like to review your existing investments, ISAs and pensions and, as an example, their investment allocations, then please contact the team at either our Guildford (01483 578800) or Woking (01483 330800) offices to arrange a time to meet. To reference this further, you may find our Investment Risk Scale of interest on our website in your financial planning. A link to this can be found here.

No individual advice has been provided during the course of this Blog.

Keith Churchouse, FPFS 
Director 
ISO22222 Certified Financial Planner 

Chapters Financial Limited is authorised and regulated by the Financial Conduct Authority, number 402899.