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Slow recovery and low inflation?

Various European countries have confirmed that gradual relaxations will now occur allowing more businesses to restart and more people to work. What can we expect from here?

Various European countries have confirmed that gradual relaxations will now occur allowing more businesses to restart and more people to work. What can we expect from here?

John Redwood

in Features


Despite the lifting of some lockdown restrictions, there will continue to be major restrictions on public transport, with a presumption that many people will still work from home to avoid undue pressures on mass transits into city centre offices. Governments are being very cautious over the pace and magnitude of the changes and are insisting that where factories and offices open-up, they observe strict rules on social distancing. There are also tensions within countries, with regional or state-level governments often at odds with federal or national governments over the speed of relaxation. This complicates the return to work.

One of the things investment managers have not had to worry much about since the great banking crash and recession 2008-9 is inflation. The US and especially Europe picked up something of the Japanese condition from the banking crisis. No matter how many yen Japan prints or how much debt its government issues, the rate of inflation stays near zero.


People used to think there were unique features to Japan that meant the West would be more inflation prone in the pre-crisis way. The Japanese are an ageing society, with many people saving for fear of running out of money in retirement. Japan is a relatively closed economy, with little migration and established cultural and spending habits that the economy can supply easily.

In the long aftermath of its spectacular banking and property crash at the end of the 1980s there was a reluctance or inability of banks to lend and companies to borrow on a large scale. The government was able to overspend and borrow massively because the private sector was so busy saving. The Bank of Japan discovered that it could create large sums of extra money to buy up government bonds, keeping the ten-year interest rate at zero. What looked like a bizarre system based on excessive borrowing and money creation proved to be remarkably stable, generating little or no inflation. The Japanese owed the state debts to each other, and they were eminently affordable at zero interest.

As the last decade wore on, more people started writing articles that maybe the Euro-area was becoming like Japan. It too had low inflation. Its banks were impaired in lending lots more to the private sector. The area overall ran a large balance of payments surplus. It controlled the amount its member states could borrow and kept interest rates very low or negative through large bond buying programmes. It too had stability with low growth.

Inflation outlook

As we seek to chart a course through the current unprecedented collapse of output in the major economies, the consensus view which we share is in the short term we will see lower inflation. An absence of demand in many areas reflecting shutdown of supply and loss of jobs and incomes may trigger more price cuts when efforts are made to tempt consumers back to non-essential purchases. There have been price rises in the limited number of areas in strong demand, including protective clothing, various health supplies, and foods through supermarkets, but overall with large falls in oil and other commodities we look set for a year of low inflation.

Further out, there is more of a two-way argument. It could well be that inflation remains very low, with more of the world following the Japanese model. If the rest of the advanced world settles for little or no growth, there will be fewer inflation pressures. If consumers remain nervous, and keen to save, there could be less inflation. If unemployment stays high after the shock, there will be downwards pressures on wages and less consumer spending to bid up prices. All that argues for an impaired recovery with little or no inflation.

A potential spike?

Were the recovery to be more vigorous it might be different. If the central banks do not abate their huge expansions of money and credit in good time, there could be too much money chasing too few goods. If the new pattern of growing demand concentrates itself, there could be big price pressures in the favoured areas. If the big recession takes out too much capacity in a range of sectors there could be more price rises from the survivors taking advantage of the situation.

All the time we live with social distancing, a number of sectors will have good arguments to move to higher quality higher price services. Restaurants with only half the tables and more space will need to charge more. Planes with fewer seats and lots of spread room will have to put up ticket prices. Hotels with fewer guests and fewer ways of taking money off people in crowded spaces will expect higher room charges. Factories on half their usual output may put up prices if they have a premium product that is much in demand. For the time being, the big fall in demand should overwhelm most efforts to push up prices, outside a few popular areas.

So, there are scenarios where a mixture of money excess, capacity reductions and enforced new ways of delivering service could conspire to push prices up. Inflation-linked government bonds offer some protection – and are worth considering were inflationary pressures to reappear in due course.

Nothing on this website should be construed as personal advice based on your circumstances. No news or research item is a personal recommendation to deal.



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