DIY Investor Magazine
/
2015 Issue
6
Price rises in Britain have fallen to just 0.5%
as measured by the Consumer Prices Index.
While this is welcome for consumers and many
businesses, the Bank of England is tasked to
maintain inflation at around 2% and will treat this
14 year low with caution. Why? Well the answer
can be found close by.
Across the channel, Eurozone policymakers
are coming to terms with deflation as prices in
December actually fell by 0.2%. Of course a lot
of this has to do with the falling oil price and if
energy is excluded, other Eurozone prices rose
by a modest 0.6%.
But the effects of the 2011 interest rate rise
and painful austerity are really being felt in the
weakest parts of that extended economy. In
China, there is also a fear that the economy
could slip into deflationary territory.
There is plenty that governments can do to
reflate an economy as the recent quantitative
easing experiment indicates.
But the fact is that investors who perhaps in the
past defended themselves against inflation are
now considering the spectre of falling prices.
Inflation is a danger because it erodes the
purchasing power of money and the worth of
fixed income products such as bonds.
Equities have often been employed by investors
to counteract inflation (particularly if they offer a
mix of income and growth) but can also mean
that portfolios end up accepting more risk.
The great threat of prices falling is that because
this increases the purchasing power of money,
a ‘deflationary spiral’ can follow where we are all
reluctant to spend since goods will be cheaper
tomorrow. This is especially true of major capital
spending such as property. An economy can
simply slow down.
A bit of deflation is unlikely to have this effect as
consumers actually take advantage of cheaper
goods but policymakers clearly worry that the
problem could become more embedded. Quality
bonds can be rather attractive to investors in
deflationary times since the value of the income
they produce can increase in real terms while
monetary conditions in the economy can be
expected to be loose meaning low interest rates.
Defensive sectors producing consumables that we
use irrespective of the state of the economy can
also find a prominent place in portfolios. Indeed
many of these tend to offer a good mix of income
and growth. And of course global diversification
can ensure exposure to economies and sectors
unaffected by the plight.
Given the tools at the disposal of policymakers, it
seems unlikely that Britain will suffer from serious
deflation, even if the problem is much harder to
fix across Europe. If truth be told, a dose of mild
deflation driven by falling oil and food prices
should not worry investors and could be welcome
for business and consumers. Nonetheless, there
are adjustments that investors can make to
portfolios to protect wealth from rising and falling
prices alike.
SHOULD WE IGNORE
INFLATION AND THINK DEFLATION?
INVESTORS WHO PERHAPS IN THE
PAST DEFENDED THEMSELVES AGAINST
INFLATION ARE NOW CONSIDERING
THE SPECTRE OF FALLING PRICES.
