Inflation déjà vu

In April 2, 2015
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It seems every month we keep hearing the same story in the press about inflation and how low it currently is. That is because in February inflation fell to zero. As I’m sure you have seen in the press, this is the first time that this has happened since records began.

And now Bank of England Chief Economist Andy Haldane suggests that the Bank of England may consider cutting interest rates further, rather than increasing them.

The media, of course, are suggesting that this is a bad thing because low inflation can prevent people from buying things in the expectation that their purchases will be cheaper in the future. In a classical economic model this is indeed the case. But models are not the real world, they are just models.

We need to look to why inflation is so low, before we can decide if it is a good or a bad thing.

The main underlying cause for the present low level of inflation is falls in energy prices. These price reductions affect virtually everything you buy that is not a service. Hence the lowest oil price in the last 20 years results in low inflation.

While oil prices have since stabilised, the inflation figure produced by the Office for National Statistics (ONS) reflects the year to February. This means that there will need to be a period of several months when the oil price is steady for the previous falls in oil price to begin to drop out of the calculations. Therefore, we can see inflation being at this low level or even lower for the next six months or so. If oil prices remain steady for the next four months then you will see inflation increase, although it will still be below the 2% target for some time.

So will people stop making purchases?

Will you buy less at the supermarket in case the bananas are cheaper next month? Of course not. Will you stop spending on electricity or gas because they may be cheaper next month? Of course not.

In fact, very little of your expenditure is affected by low inflation because you will buy these things anyway. So if your petrol bill, supermarket bill, electricity bill and gas bill are lower, is it a good or a bad thing? I think that answer is clear.

Also it means that your investments have to produce a lower return in order to give you a real return. So this is generally good news for investors.

I think therefore the recent falls in inflation, because of their underlying cause, are a good thing and we should welcome them with open arms.

 

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Jasmine has been a qualified Financial Planner since 2008. She has also been a member of the Society of Will Writers since 2012. She is passionate about helping Clients build their wealth and achieve the financial lifestyle they desire. Her areas of expertise are that of Savings, Investments, Pensions and Retirement Planning.

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