Inflation Looks Set To Fall Fast
UK inflation looks set to fall fast over the next year. House prices too. That's good in some ways, but it also suggests that we're entering a bad recession.
UK manufacturers reduced their prices by 1% in October. That's the biggest monthly fall since 1986. Economists had only expected a fall of 0.5% according to a survey by Bloomberg.
The fall was at least partly due to falling prices for oil and other commodities. The general economic picture probably played a part too. If customers are suffering, they may only be prepared to buy if prices are cut.
Mortgage market
We also saw some poor numbers from the mortgage market today. Nationwide said that mortgage lending had fallen 72% over the last year. The building society lent £1bn in the six months to September, down from £3.6bn a year earlier.
Nationwide also warned that it expects house prices to continue to fall in 2009 and 2010.
Libor
On the plus side, Libor - the rate at which banks lend to each other - has continued its recent fall. 3-month sterling Libor fell today from 4.49% to 4.42%. A week ago it was at 5.78%. Libor has a big impact on discounted and tracker mortgage rates, so that's good news for some borrowers.
What does this mean?
Well, consumer inflation won't stay at its current level of 5.2% for long. That's for sure.
As inflation tumbles, the Bank of England may feel able to make further cuts in the base rate which could lead to cheaper mortgages and lower returns on savings rates. So good news for borrowers. Not so good for savers.
But the overall picture worries me a lot. When the base rate is cut by a third, it doesn't feel like we're entering a short, mild recession. I fear something more serious is afoot.
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The problem with deflation as people have already said above is that it often (but not always) corresponds to severe contractions in the economy. This happens primarily because consumers will put off purchases if they believe they can buy the same thing for less next year and people will be less willing to borrow and invest if they believe prices of goods will provide lower profits or the eventual thing produced will be worth less than that needed to build/invest in it.
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Ultimately, though, deflation is great for us as long as our incomes and the value of our assets don't deflate as well.[br/][br/]Yes - if your mortgage payments stay the same they will [i]look[/i] higher relative to your other expenditure in a period of deflation, but if everything else is becoming less expensive and your income doesn't fall things look fine and dandy.[br/][br/]Deflation itself cannot be bad for your wealth - the problem is the other implied effects that tend to accompany a recession, such as depreciation of the value of your assets (equities and property values) and the increased risk of unemployment.
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@UpHillAllTheWay,[br/]Another side of deflation I only came across a couple of days ago is looking at debt.[br/][br/]I have understood for a while that a long term debt with inflation reduces in effective cost.[br/]e.g. If we look at a mortgage with a 25 year term and fixed monthly payments, as the inflation over that 25 years stacks up the monthly payments are fixed but their comparitive value drops (it is fixed and everything else costs more).[br/][br/]However, if we are in a deflationary period, the opposit is true; that is to say, the comparitive value of the money paid to cover each month's mortgage payment is more (it is fixed and everything else costs less)![br/][br/]I hadn't thought of this until somebody here in Fool towers mentioned it to me!
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13 November 2008