Global disinflationary forces are playing out but for how long?
David Absolon, investment director at Heartwood Investment Management comments on the global inflation outlook.
Headline inflation measures across developed and emerging economies have disappointed consensus expectations over the last few months. Global central banks, however, remain on message that energy price-effects will be transitory and inflation will return to a trend over the longer term. These reassurances are not being believed by the market and there are growing fears that deflation is becoming an entrenched feature of the global economy. In the US, Europe and the UK, the implied breakeven inflation rates on 5- year inflation-linked securities have fallen steeply since July, and stand well below most central banks’ targets of 2%.
Some economists argue that lower oil and other commodity prices are less a windfall gain for Western consumers and more a significant deflationary pressure worldwide. The renewed slide in the oil price has intensified disinflationary pressures in recent months, and we accept that deflation risks have increased which might prompt a more severe economic slowdown. But in our view, this scenario continues to remain a small probability and we maintain our core conviction that developed economies, and in particular the US, should see a return to a more normalised environment, albeit subject to a lower growth and inflation outlook than relative to history.
Over the short-term, there are two trends that should provide more comfort that developed economies can withstand global disinflationary forces. First, we would need to see evidence of a stable oil price. This may seem an elusive prospect after last week’s price gyrations (Brent crude oil fell 6%), but there are signs that the equilibrium between supply and demand is starting to adjust. US production levels have been cut as expectations of rising global demand have been reported. High profile energy companies have also announced cutbacks – for example, Royal Dutch Shell has announced it would stop drilling for oil off Alaska’s Arctic coast – at the same time as OPEC has warned of a sharp decline of investment, potentially leading to higher prices.