It came as somewhat of a surprise that a similar trend may be on the cards for the UK economy, with Bank of England governor Mark Carney now prompted to write an open letter to chancellor George Osborne explaining why inflation has dipped one percentage point below its 2 per cent target.
Annual UK inflation as measured by the consumer prices index fell to a 15-year low of 0.5 per cent, its joint lowest ever level, in December, according to the latest official numbers.
This is largely seen as a consequence of 2014’s oil price plunge, as shown in the graph below, according to Azad Zangana (pictured), senior European economist at Schroders.
“Compared to just six months earlier where inflation was a healthy 1.9 per cent, the fall has been dramatic and it takes the CPI rate to its lowest level since May 2000 – even lower than the deflationary period during the financial crisis,” he said.
Performance of index in 2014
Source: FE Analytics
Zangana says this will lower petrol prices at the pumps with falling energy bills also further weakening inflation in the coming months as wholesale reduction energy costs are passed on to consumers.
But should investors worry or make changes to their portfolios? Adrian Lowcock, head of investing at AXA Wealth, says they should not, despite the figures adding to concern in an already fragile market.
“Continued downward inflation surprises will add to growing fears about mounting disinflation pressures in the UK economy. At the same time it should boost consumer spending in coming months as real disposable incomes rise,” he said.
“Indeed rising wages pressures from a tighter labour market conditions could still prompt the Bank of England to raise interest rates before the end of 2015, although current expectations are for a modest interest rate hike in mid-2016.”
“Investors are able to find a wide range of savings and investments which offer a real yield [one that is above the rate of inflation]. The average yield on the FTSE 100 is 4.69 per cent, whilst corporate bonds offer a yield of 2.9 per cent. For risk adverse savers cash is also producing a real return of 0.957 per cent on 12-month deposits.”
However, he says when compared to the retail prices index the situation looks different with 10-year government gilts offering a yield of just 1.52 per cent, slightly below RPI, but he warns against the income hungry moving quickly away from risk assets.
“Investors should be careful of reading too much into this information. The fall in the oil price has been very rapid and will impact the figures for some time. That said the price could also rebound quickly, wiping away some of the effects on inflation and causing it rise in the future. Investors should not get too concerned or excited by a lower inflation as it is a temporary effect of the falling oil price.”
Kames Capital head of multi-asset Scott Jamieson agrees the fall in prices could boost consumer spending in a manner similar to the windfall in PPI reimbursements in the past few years.
“Whether the trickle impact of paying less at the pumps will generate the same result remains to be seen. If not then with Europe now in deflation and with Japan effectively exporting its own deflation the downward bias to inflation prints is likely to continue,” he said.
“The money markets now see no rate change out of the Bank of England for at least 12 months. It is hard to see that they are wrong.”
Helal Miah (pictured), investment research analyst at The Share Centre, notes that delays to the interest rate rise will be good for stocks and says equities remain the asset class of choice for investors looking for growth and income.
Dr Dennis Novy, an associate professor of economics at the University of Warwick, is more concerned, however.
“There is a risk for the UK economy. Inflation is inching close to the danger zone of outright deflation. Once prices stop rising, consumers and businesses delay spending and can pull down the economy. If that happens, it would be time for the Bank of England to have another look at unconventional measures such as quantitative easing,” he said.
“Many voices, especially from the City, have long called on the Bank of England to finally raise interest rates. But the latest inflation numbers and weak wage growth make higher interest rates unlikely any time soon.”
This would, however, be a potential boon to equity markets, says Brenda Kelly, chief market strategist for IG, arguing that several areas could benefit.
“There obviously areas of the market that will benefit from lower prices. Consumer discretionary and utilities stocks as well at the airlines could benefit as people will have more money in their pockets with oil cheaper,” she said.
“However, the problem is not exclusive to the UK with the eurozone and the US affected also.”