A little bit of inflation is fine for share markets. A couple of years ago some investors were very worried that the advanced world was relapsing into deflation. If prices generally start falling, people put off buying things on the reasonable grounds they will be cheaper later. This can trip an economy into recession or slow its growth badly. Investors did not want the West to catch the Japanese deflationary cold.
Coming into 2017, inflation picked up some speed. US inflation hit 2.7%, German inflation reached 2.2% and UK inflation 2.9%. The euro area as a whole reached 1.9% despite the high unemployment in the south of the zone. The main force behind this was the sharp rise in oil and commodity prices last year, pushing up transport costs and general goods prices where energy and raw materials are used in their production. More recently the oil price and some commodity prices have slackened. On cue, US inflation has dropped away to 1.6% in June and Euro area inflation to 1.3%. The UK figure for June also showed a fall.
Some have argued that UK inflation is the result of the weaker pound. This is a difficult argument to sustain. The Japanese have experienced a weaker yen in recent years but that has not triggered inflation. The UK’s rate has performed similarly to the German and US rates where their currencies have been stronger. The Office of National Statistics today has said that commodity prices are an important part of the explanation of UK price changes generally. The UK has a bit higher inflation than the US and the Euro area today. Special factors include increases in Council tax and energy prices resulting from the UK’s decarbonisation strategy.
There are no signs in any of the advanced markets of a big push to wage inflation following the increase in prices. As a result the tail off in general inflation reassures central banks and delays any move to higher rates that they might have been contemplating. This in turn should prolong the recovery. The absence of wage inflation is a disappointment for employees and a depressant on future levels of spending and output. Meanwhile intense retail competition is keeping shop prices down. The arrival of internet based business models in many areas is also pushing down prices and forcing traditional businesses to alter their approach and cut their costs.
Markets are likely to get just that little bit of inflation they want, without it getting out of control for the time being.
The above article was first published by Charles Stanley on 18th July 2017