markets & strategies
The global economy should strengthen, led by improvements in the US economy and the fall in oil prices, diminishing geopolitical worries and rising confidence, according to market research conducted by Foreign & Colonial.
The upbeat report noted there is little chance of the global economy suffering a long, drawn-out and damaging period of deflation.
According to Andrew Hornig, chief strategist, there is a reassuring picture in the UK, where inflation remains above the Bank of England's ceiling and demand is healthy.
In addition, reflationary monetary policy in the US reinforces the US's commitment to take pre-emptive action to guard against deflation.
He said the decline of US dollar versus the euro means the US is 'exporting' deflation to continental Europe, where rising unemployment and weak confidence is affecting demand.
As such, the European Central Bank is likely to reduce rates to kickstart domestic demand and weaken the euro.
There is, in general, a high level of confidence in the ability of central banks to support demand, partly reinforced by the effective and immediate action taken post 11 September 2001, said Hornig.
This is unlike Japan, which has seen a sustained period of deflation for some years. The failure of Japan's government and central bank to agree on the appropriate action, or put any action in place has exacerbated its situation.
'Provided there are no significant or unexpected shocks, demand should remain strong and the chance of deflation small,' said Hornig.
He suggested if deflation did take hold, the way to tackle it could be to cut interest rates to zero. Spending can be stimulated by lowering the interest rates on longer-term government bonds, thereby committing to keep interest rates very low for an extended period.
In a deflationary scenario, Hornig also suggested announcing explicit ceilings for longer-dated bond yields and keeping yields below this ceiling by purchasing bonds.
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