Don’t fear low inflation: It’s great news for consumers while it lasts

John Redwood
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Concerns about UK deflation: Are times are too good for shoppers? (Source: Getty)
The latest retail figures in the UK showed good growth. Things are also looking up in the US and in much of the euro area. The world economy has settled into a period of steady growth with very little inflation in the major economies. Indeed, just yesterday, official figures revealed that consumer price index inflation in the UK edged up only very slightly to 0.1 per cent in July, from June’s zero per cent. So why are there still concerns about deflation, and why are we still debating when there will be an interest rate rise in the US and the UK?

The worry has been that times are too good for shoppers. In the UK, the news is dominated by arguments over whether the price of milk has fallen too far and is now too low. The latest fall in oil prices is producing better news at the pumps, leaving drivers with more money to spend on other items or with less of a struggle at the end of the week. In western shops, there is an abundance of reasonably priced manufactured items, as China and her leading Asian competitors strive for customers’ attention.

China, meanwhile, has just announced a small devaluation of her currency, to make her exports a bit cheaper still. Raw material prices generally remain weak, with plenty of supply around in energy, metals and the main foodstuffs.

So what is the concern? Western investors are still a bit phased by falling prices, after years of watching governments fighting inflation. They fear it means insufficient demand, slower growth, or even a move back into recession.

The UK milk price is an interesting case in point. The Department for Environment, Food and Rural Affairs (DEFRA) farmgate price to farmers was 31.7p a litre in July 2014. This fell to 23.7p in July this year, despite Tesco, Sainsbury’s, Marks and Spencer and Waitrose paying farmers more than 30p a litre for liquid milk as part of their policy of keeping supply capacity in the UK and reflecting the costs of production in their payments.

Morrisons, Lidl and Aldi, however, reflect market movements more in what they pay, while much of the milk that goes into the manufacture of milk-based products sells around the market level, which is well below farmers’ estimates of current average costs. There is an oversupply of milk, exacerbated by Russia’s decision to retaliate against EU sanctions by imposing sanctions of its own on the EU, which hit EU dairy industries by banning sales to Russia. The UK is witnessing an important debate about whether prices can go too low, leading to reductions in UK capacity now with more reliance on imports in the future.

But elsewhere, falling prices are unalloyed good news. Average diesel prices at the pumps in the UK have fallen to 114p a litre, with some now below 110p. Diesel has gone below petrol, which now averages 115p. The supermarkets are helping chase prices downwards as they make offers to customers to attract them to their sites.

The fall in energy and raw material prices is boosting the spending power and the real incomes of many advanced country consumers, who gain more choice on what to buy as their money stretches further. None of this means we are about to dip back into recession.

The monetary authorities of the US, UK, the euro area, China and India are all intent on following policies which allow and foster growth. Interest rates remain at extremely low levels in the US, UK and the euro area, and output is generally expanding. Before the credit crunch of 2008, governments were seeking ways to experience sustained growth in output and incomes with little or no inflation. Now, for the moment, we have reached just such a situation.

The fears of deflation are overdone, but mean interest rates are staying lower for longer than most commentators and forecasters expected last year. Much of the downward pressure on prices is coming from successful expansion of output of everything from milk to oil. This, in turn, will have an impact on which parts of the world sustain their market shares and which companies can make good money despite the weakness of prices for many products.

More than ever, successful companies need unique technology, design, or service to give them an edge and some pricing power.

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