Inflation collapse – should central banks raise interest rates or not?
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Version 0 of 1. It is a long time since there was any real inflation in the UK economy. Not since the oil price-induced spike in 2011, which sent petrol and gas costs spiralling, have consumers suffered such a sustained attack on their living standards. Since then it has been downhill all the way, reflecting the turmoil in the eurozone and then the slowdown in China, the world’s economic engine room. This year prices have flatlined. And the lack of energising forces in the world economy look like keeping prices flat for some time. Goldman Sachs said last week the oil price could fall to $20 (£13) a barrel from the near $45 a barrel it currently commands. That’s a long way from the $107 West Texas Intermediate crude hit in June 2014. There are two ways for central bank interest rate setters to read this collapse in inflation. It could be a global phenomenon that national policymakers can ignore should their own economies be doing well. This would allow the US Federal Reserve to press ahead with an interest rate rise on Thursday and Britain likewise next spring. Both economies have created lots of jobs in the past three years and wages have crept higher. Business confidence is high and consumers are borrowing to spend with a renewed vigour. The alternative view would concentrate on the continued lack of demand in the global economy and the negative impact on trade. While Britain’s wages might edge higher, they are unlikely to have their traditional effect – an upward pressure on prices. Wider forces – from low oil prices to weak commodity values and a surplus in global labour supply – will push costs down, not up. In this environment, higher interest rates are a growth killer and central banks must sit on their hands. There is no reason to increase. If anything, there is a need to go the other way and for central banks to directly support growth with extra investment. But never underestimate the lobbying power of the investment community. As far as the billion-dollar pension funds, endowment funds and sovereign wealth funds are concerned, we need to see higher interest rates and soon. They and their clients have suffered seven years of meagre returns, or losses from investments in currencies, junk bonds and stock markets. They are not the only influence on central bank thinking. Nevertheless, they will want their accumulation of assets to be rewarded with higher, safer returns. And soon. |