Choosing between the lesser of two evils

Inflation, deflation or stagnation? Asset managers concur deflation poses the greater danger to developed world economies

The Eurozone’s overall 1.6% inflation masks a broad divergence between the conditions in different countries, from deflation in Ireland to above-target inflation in the UK and, perhaps surprisingly, Greece. In the face of this, most central banks, excluding the European Central Bank (ECB) itself, are showing surprising willingness to print money – potentially fuelling more inflation – or to devalue their currencies, to cheapen debt.

Tim Drayson, economist at Legal & General Investment Management, said the euro single currency bloc faces the greatest risk of deflation, but its central bank is least likely to boost liquidity artificially to counter that.

“The US Federal Reserve seems almost certain to undertake additional quantitative easing, but it would take more convincing evidence of deflation for the ECB to do it, not least because it has to decide which government bonds to buy, in contrast to the UK and US. That clouds the ECB policy response. Europe’s peripheral countries are already struggling with deflation, but Germany will be unwilling to allow inflation.”

Cambiz Alikhani (below), chief investment officer at Iveagh, said given its history Germany will stay “in the hawkish camp” on inflation. He added that German exporters are benefiting from the low euro that results from muted expectations of Eurozone growth. Meanwhile Richard Jeffrey, Cazenove Capital Management chief economist, said: “Germany is getting an immense uplift from export growth to Asia, so it is in an entirely different situation from southern Europe.”

That said, the sovereign debt problems of Portugal or Greece could in his view still “drown out everything else, as southern Europe is in extremely severe circumstances”.

 

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