Central banks look like they have tamed both the inflation tiger and the deflation risk. But that’s in an environment in which there has been sufficient growth to preclude a general drop in prices, yet not enough growth to get wages and, thus, prices moving up strongly.
Whether a benign environment will continue is not certain. The plunge in oil prices made last year an anomaly from both an inflation and a growth perspective. Reported inflation plunged due to lower gasoline and heating/cooling costs while those lower costs acted like a tax break for consumers and a price increase for businesses, thereby stimulating growth.
But that was a one-time event. Even if oil prices stay at current levels, consumers and businesses won’t be better off than they were last year. And if prices start to creep up, as most global strategists interviewed for this report expect, there would probably be some negative impact on both retail sales and profit margins, particularly as reported inflation will increase, which could lead to higher wage demands.
We are in a strange period because there are both inflation and deflation risks, says Stephen Lingard, director of research at Franklin Templeton Investments Corp. in Toronto. “The drop in oil and other commodity prices is deflationary,” Lingard says. “But, for the first time in a while, it looks like inflation could gain some traction.”
Peter O’Reilly, global money manager with I.G. Investment Management Ltd. in Dublin, puts it another way: if there is a big rally in oil prices, that will feed through to inflation. But there also is significant excess capacity in various industries, which could lead to price declines.
Certainly, some strategists think there could be wage pressure in the U.S. Craig Basinger, chief investment officer with Richardson GMP Ltd. in Toronto, points out the Arkansas-based Wal-Mart Stores Inc. has raised its minimum wage.
However, most global strategists don’t think growth will be strong enough in the U.S. for an upward wage/price spiral to develop. Growth is expected to stay moderate, especially with interest rates now rising. Nor is there any doubt that the U.S. Federal Reserve Board would quickly push interest rates higher if there were any sign of significant inflationary pressure from wages.
Strategists are more concerned about the deflation risk in Europe and Japan. Neither is growing strongly, and they are growing at all only because of quantitative easing. With aging populations, both have an underlying sluggishness and fragility that is fertile ground for prices to move down if consumer demand falters. And once prices generally start moving down, the declines gather momentum.
There are also concerns about deflation in emerging economies. A number of key economies, such as Brazil and Russia, are in recession and the declines in consumer spending could lead to deflation. There are even concerns about China if consumer spending is weak enough to result in declining prices.