Global inflation is set to stay down and evidence of a recession is being revealed across the globe,...
Global inflation is set to stay down and evidence of a recession is being revealed across the globe, says Nigel Morgan, economic strategist at Old Mutual Asset Managers (OMAM).
Simon Rubinsohn at Gerrard, says: 'The latest inflation report by the Bank of England was remarkably gloomy in its assessment of the outlook for the economy. The fact that it now believes growth will be weaker than previously anticipated is hardly a surprise given the sentiments expressed in the statement accompanying the UK base rate cut at the beginning of the month. More significant is that, even after this lowering of expectations, is the perception that the risks to economic activity is still largely on the downside.'
Industrial production has fallen from its peak levels, which were recorded as long ago as last year in many countries, says Morgan. 'The decline in output has been sharpest in emerging economies and some smaller developed European markets, but also extends across the G-7.'
Sales volumes are under pressure causing businesses to respond in two ways, says Morgan. 'Firstly, they are cutting prices or offering other inducements to customers, which is sustaining some volume of sales but at the expense of profit margins. Earnings per share are falling around the world, leading companies to defer planned investments and hiring staff while seeking to shred inventories. There is a downward momentum as businesses successively cut back spending, followed by individuals as their employment prospects deteriorate.'
Secondly, businesses are seeking to transmit the downward pressure on their prices to costs. He adds: 'Technical developments like the internet help accelerate the process, but it is the competitive drive that commits businesses to seek the best value for money. Wholesale price inflation has almost disappeared while the prices of raw materials and other internationally traded goods have fallen heavily over the past year.
'Domestically, the focus is on curbing labour costs and the US has succeeded in keeping labour productivity growing even though output is falling. With input costs falling and labour costs well contained, inflation can be expected to continue to fall sharply while demand remains weak. The synchronised global cycle of demand is likely to take some months to reverse its downward momentum, so inflation is very likely to keep falling over the balance of the year. With central bankers tracking inflation targets, it is similarly likely that interest rates will be reduced.'
Experience of the past economic cycles suggests inflation is likely to be even lower in the first year of the cyclical recovery than in the depth of the recession, says Morgan. Historically, inflation continued to fall in this way as the US economy recovered in 1976, in 1983 and again in 1991, he adds.
Morgan says: 'This implies that both cost and price inflation are likely to fall further in 2002, with unemployment rising even as demand recovers to take up some of the spare capacity. Policy-makers will be able to keep interest rates low for much of the next year. Investors have yet to adjust to a world of sustained low inflation and as they do so both bond and equity prices are likely to rise.'
• Sales volumes sustained.
• Labour productivity growing.
• Businesses tackling pricing pressure.
Moves to overweight equities and fixed income
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