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CEO AllenWargent Property Buyers, & WargentAdvisory (institutional). 6 x finance author.

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Friday, 6 November 2015

Disinflation and deflation

Bank of England

Wrapping up a triumvirate of British-themed posts, I was in London yesterday while the Bank of England voted to keep interest rates on hold at 0.5 per cent, thereby racking up 80 consecutive months of no change since March 5, 2009.

Governor Carney warned that due to the subdued inflation outlook it may be some time before the first hike takes place, with the Bank of England in no rush to raise interest rates.

I thought that following an engagement in the Square Mile I'd take a look around the Bank of England Museum on Bartholomew Lane to see what has changed over the past decade.

Firstly, it was noted while wandering around this excellent museum that the ubiquitous dumbing down of the English language has pervaded even the hallowed walls of the 'Old Lady of Threadneedle Street' ("there's always unforeseen events" etc.).

This appears to be increasingly common in Britain today (I must admit I done it meself before, but I never would of done it in formal written English).

However, the most urgent change has been the time and effort that has evidently been put in to explaining the role of Quantitative Easing ("QE"), being the creation of new money electronically to buy assets. 

If you had used the term "QE" a decade ago you'd generally have been met with blank looks, yet today the Bank has a special FAQ section on its website to explain the unconventional policy and how it works.

Better still, visiting school children can learn through interactive technology and displays how the Bank aims to hit its 2 per cent inflation target by starting QE (press the red button!) and stopping QE (press the blue button!). 

Is it me or does that red button look a tad sticky?

Sign of the times

One could not help but ponder that there may be a generation of kids who grow up believing that QE is the primary policy tool used to target inflation, rather than the traditional lever which has been the setting of the official bank rate.

Indeed in some parts of the world this has pretty much been the case for more than half a decade now, with central banks turning the asset-purchasing taps on and off in response to the economic outlook.

I also noted in yesterday's Evening Standard a healthy level of debate as to whether the British government should be engaging in QE in order to fund infrastructure projects, with the general feeling seemingly being "yes, if only they could be trusted to do so sensibly!".

Interestingly the Evening Standard became a free newspaper in 2010 in order to boost circulation, after some 180 years as a paid-for title. 

So some things in Britain - such as motor fuel, tech goods, and London evening newspapers - have clearly been getting cheaper.


Fighting raging inflation seems to have become yesterday's war in a number of developed countries, with deflation instead often being seen as the greater threat.

In part this may be due to the ageing of the Baby Boomer cohort, the proverbial tennis ball passing through the demographic snake.

Largely thanks to our immigration policy, the population pyramid in Australia is not projected to become as "top-heavy" as those in some of other developed countries, with Japan representing the classic basket case in this regard.

I discussed these demographic projections recently in more detail here and in The Australian here

Household debt

Another driver of lower inflation may prove to be the role of increased and increasing household debt.

Household Finances graph

With much of the developed world embarking upon a household debt binge as interest rates declined through the 1990s and beyond, interest rate hikes - or even the threat thereof - today have the potential to impact consumer confidence more than was formerly the case.

It is all too easy to forget that as recently as 2008 the official cash rate in Australia was 7.25 per cent, which seems hard to imagine today as household mortgage debt rises inexorably towards $1.5 trillion.

Today the official cash rate in Australia is just 2 per cent, and Governor Stevens noted in a speech this week that if another change to monetary policy were to be required in the near term, it would "almost certainly be an easing".

While in the short term record low interest rates can be associated with rising inflation, the longer term impacts are not so easy to predict.

Real estate in a low inflation environment

It is important to remember that whether we are in a low inflation environment or a high one, it is vital for investors in all asset classes to target returns that are in excess of the rate of inflation.

It had been argued in the 1990s that property investment would no longer work as effectively as inflation declined, but as I looked at here back in 2012, this need not necessarily be the case.

In fact, the internal rate of return (IRR) on a property investment scenario can be remarkably similar in a low interest rate/low inflation environment and in a high interest rate/high inflation one. 

However, asset selection is important, as is an element of market timing. 

As yesterday's House Price Index (see link) in the UK itself showed, while dwelling price inflation in London has consistently wiped the floor with the rate of consumer price inflation, over the past decade regional property has largely gone backwards in real terms.

UK house prices are forecast to rise by 20 per cent over the next five years, but the rate of consumer price inflation for now is stuck at precisely zero (0.0 per cent).

Meanwhile homewners are enjoying the lowest borrowing rates on record, the flip side of the "hospital pass" facing some first home buyers today.