Why 2012 could be the year we start to worry about deflation


11:10 am - January 13th 2012

by Duncan Weldon    


      Share on Tumblr

In December last year I noted how the fall in UK inflation might not be entirely good news.

The fall in inflation was being accompanied by a fall in wage growth and so not providing a boost to disposable income.

I also noted that it was important to understand what was driving this fall in inflation fall.

As I wrote then:

This week’s retail sales figures showed a monthly fall of 0.4% in volume terms. As Bloomberg noted the fall in inflation has been driven by “food and transport prices as the prospect of another recession weighed on the economy”.

As the economy has weakened retailers are now engaged in a full scale ‘price war’ in an effort to hang onto sales.

Rather than a reduction in inflation supporting consumption, a fall in consumption is driving inflation lower. And real wages aren’t improving as the labour market remains very weak.

Yesterday’s results from Tesco suggest that my analysis was correct.

As FT Alphaville reported, Tesco’s weak performance was driven by ‘Tesco-induced deflation’. Tesco said:

We delivered a very good Christmas shopping experience for our customers but in a highly promotional market, the volume response to our increased investment into lowering prices did not offset the deflation it has driven. The wider improvements in the shopping trip that are an integral part of strengthening our performance are still to
work through fully.

This means inflation is set to fall sharply in 2012, driven by three factors:

First, the impact of January 2011’s VAT rise will drop out of the comparison. Second, one major factor driving inflation higher in 2011 was rising commodity prices. This looks less likely in 2012, though it’s difficult to predict. Note that EDF cut gas prices this week.

Finally, retailers are engaged in a price war as they try to hang on to market share.

Add these three factors together, assume that wage growth will remain weak throughout 2012 – and you have a recipe for inflation falling much faster than many observers expect.

Add the current indebtedness of UK households into that mix and their seeming desire to get rid of personal debt and you have the potential for a real deflation scare towards the end of the year.

    Share on Tumblr   submit to reddit  


About the author
Duncan is a regular contributor. He has worked as an economist at the Bank of England, in fund management and at the Labour Party. He is a Senior Policy Officer at the TUC’s Economic and Social Affairs Department.
· Other posts by


Story Filed Under: Blog ,Economy

Sorry, the comment form is closed at this time.


Reader comments


A price war you say?

Quick RUN FOR THE HILLS!

well if wage growth is low but positive and food prices are falling (or growing at a slower rate than wages), that does add up to higher real wages, so it’s not all doom and gloom.

how does this post sit with:
1. all those people who confidently predicted QE would cause inflation
2. all those people who are sure speculators make profits betting on rising food prices and creating a self fulfilling prophecy? [global food prices are falling, it's not just Tesco cutting prices]

3. Luis Enrique

on second read, I am trying to locate the bits which “might not be entirely good news” – have they been edited away?

The only sense in which a fall in inflation is bad news, afaik, is when wages inflation is falling (either at the same pace or faster than prices).

But the contents of this post is all about prices – supermarkets cutting, commodity prices falling, tax-induced prices increases disappearing – all of these are entirely good news .. there’s nothing in the OP arguing that expectations of wage growth should now also be lowered … if we are now expecting prices to fall faster but wage inflation expectations are unchanged, that means real incomes are rising, hooray.

4. Duncan Weldon

Hi Luis,

The bad news is that inflation is falling (in part) because of a lack of demand. Falling commodity prices and the end of the VAT effect are the good news.

D

5. Luis Enrique

thanks Duncan,

OK, so it’s a symptom of the weak economy. I suppose that would also lead us to expect slower wage growth too.

p.s. either you no longer read your yahoo email or you are ignoring your debt of one slap up meal (although having checked (here and here) the bet actually covered a three year span)

@2 Luis – surely the problem will be a deflationary downward spiral.

Consumers have already shown themselves to be increasingly savvy, with the retailers losing the perennial when will the sales stand off.

If inflation continues to fall (and falls very fast) consumers will hold on to their cash, convinced they will get a better deal later and growth will be even slower

7. Luis Enrique

Redfish,

agreed, a situation where prices (and wages) are expected to keep falling is generally regarded as a bad thing … but things like the VAT rise working its way through, supermarket prices wars, and commodity prices falling are more like one-time than recurring events (commodity prices may continue to fall for some years) and besides the BoE isn’t going to sit on its hands if it looks like inflation will undershoot its 2% target.

I think its more natural to see inflation tailing off as a good thing – last time I checked around here, everybody was worrying about inflation being too high. I don’t see that we have to worry about getting in the grip of a deflationary spiral.

8. Leon Wolfeson

The government will be doing QE – a lot more QE – to make sure it stays high…

@2 – It has. Really think 5.2% came from nowhere?

9. alienfromzog

The unsaid part here is that deflation is a really bad thing for the economy.

Now… inflation falling closer to 2% is of course a good thing… but much lower and consumption and investment will really fall as people hold on to cash waiting for a better deal.

The interesting part, is what the BoE will do in response. The normal response to low inflation is to reduce interest rates but that could be a bit tricky at the mo. More QE might be a good thing, but in depends a lot on how it’s targeted.

A recession in the early part of 2012 seems about even money at the moment but a deflationary spiral could make for a long and deep recession into the end of 2012 and early 2013.

AFZ

Quote by OP from Tesco: “We delivered a very good Christmas shopping experience for our customers

but in a highly promotional market, the volume response to our increased investment into lowering prices did not offset the deflation it has driven.”

I deliberately broke the quote into two lines. On the first line, Tesco deliver a positive message using active expressions.

The second line is very passive, very soothing at first reading. But it is where observers, shareholders or not, should question whether Tesco has a clue about comprehension. Whether you are talking to readers of the Financial Times or the Mirror, statements should be clear and transparent. On the Mirror comprehension scale, average man on the street, the second line looks like a lie. Which it probably is.

I find it very difficult to take any economic policy remotely seriously now – the reality is that the economic orthodoxy of the last twenty five years – that is to ensure growth and the creation of wealth has failed. Isn’t it time to put social welfare policy first?
I expand upon this in the following article:
http://www.allthatsleft.co.uk/2012/01/is-it-time-to-put-social-policy-before-economic-policy/

@10. Ray_North: “I find it very difficult to take any economic policy remotely seriously now – the reality is that the economic orthodoxy of the last twenty five years – that is to ensure growth and the creation of wealth has failed. Isn’t it time to put social welfare policy first?”

Does the failure of banks demonstrate that “the creation of wealth has failed”?

You people are crazy.

14. Leon Wolfeson

@13 – Oh of course, ANY deviation from shovelling cash into the maw of the 1% is crazy. Very, very Randroid.

15. frances smith

if, after a period of higher inflation prices start to fall, is that not a period of correction, and a return to the previous position, prior to inflation, rather than deflation?

the absurd notion that falling prices are always bad for the economy is so stupid it is beyond belief that people with qualifications in economics are taken seriously and not treated as the quacks that they are.

cutting government spending is a form of internal devaluation, that includes a deliberate intention to reduce wages. to then imagine that under those circumstances that falling prices is not essential to a return to a previous equilibrium is just plain bonkers.

economis seems to have lost all sense of humanity, as well as commonsense.

16. Frances_coppola

Duncan, looks like you may be right, though admittedly it’s only one set of figures. Inflation today was down to 4.2%.

Frances, it depends what the cause of the price fall is. If the cause is that businesses are cutting prices because people aren’t spending, and the reason people have less money is because they are losing their jobs and/or their wages are being cut, then deflation is very bad news. I’m sure you can see how this can become a self-reinforcing death spiral – people cut discretionary spending -> businesses cut prices -> reduced profits -> need to cut costs -> cut wages or lay people off -> people have even less money -> people cut discretionary spending more…. Add to this the fact that households in the UK are still highly indebted, so have considerable fixed costs, and the deflationary spiral looks very nasty indeed – as Duncan said.


Reactions: Twitter, blogs
  1. 2wolves

    via @patrickjbutler Patrick Butler
    Good @sunny_hundal piece on the #spartacusreport campaign http://t.co/Efm6eZkh… #disability

  2. 2wolves

    via @BendyGirl BendyGirl
    http://t.co/Efm6eZkh… via @libcon #spartacusreport

  3. Kyron Hodgetts

    via @BendyGirl BendyGirl
    http://t.co/Efm6eZkh… via @libcon #spartacusreport

  4. Kyron Hodgetts

    via @patrickjbutler Patrick Butler
    Good @sunny_hundal piece on the #spartacusreport campaign http://t.co/Efm6eZkh… #disability

  5. Liberal Conspiracy

    Why 2012 could be the year we start to worry about deflation http://t.co/tFCsarxS

  6. Patron Press - #P2

    #UK : Why 2012 could be the year we start to worry about deflation http://t.co/wRBGkrPm

  7. roslinda

    “@PatronPress: #UK : Why 2012 could be the year we start to worry about deflation http://t.co/sYmHEKRx”

  8. Alice in Blunderland

    via @BendyGirl BendyGirl
    http://t.co/Efm6eZkh… via @libcon #spartacusreport

  9. leftlinks

    Liberal Conspiracy – Why 2012 could be the year we start to worry about deflation http://t.co/leDcZIib

  10. jmulick

    #UK : Why 2012 could be the year we start to worry about deflation http://t.co/wRBGkrPm

  11. Joel Carter

    Now we need to start worrying about #deflation? http://t.co/HfBLk4up Stop the bus, i want to get off.

  12. Henry Zeniewicz

    Why 2012 could be the year we start to worry about deflation | Liberal Conspiracy http://t.co/70MvE8wJ via @libcon





Sorry, the comment form is closed at this time.