UK enters era of deflation with CPI at minus 0.1 per cent

Why deflation is bad for those with debts

UK enters era of deflation with CPI at minus 0.1 per cent

According to the latest figures from the Office of National Statistics, the Consumer Price Index (CPI) fell by 0.1% in the year to April 2015, making it the first time in the past 55 years that the UK has experienced deflation on this measure.

There has been a lot of talk about how falling prices are good for consumers. However, what is hardly reported is the effect deflation has on those with debts.

Bad for debtors

If we enter a period of sustained deflation, as predicted by some economists such as Professor Steve Keen – the so-called Japan-like scenario – the burden of paying everything from your credit card bill to your mortgage will become a lot more onerous. On this basis, house prices will likely fall quite a long way.

The UK recovery seems to have been based on debt financing, everything from 30-year mortgages for first time buyers to people taking advantage of ostensibly cheap car finance.

Inflation shrinks debts but deflation will mean it takes much, much longer to pay that debt off. This is because deflation increases the real value money and the real value of debt.

The overall economy will also suffer. With shrinking prices will come shrinking sales, leading to falling corporate profits. They’re will inevitably be less investment and spending as a result.

Most workers can forget about pay rises, indeed pay cuts may become the norm. After all, in an era of atomised, non-unionised workforces on short-term and zero hour contracts people will be in no position to argue.

Just as worrying will be the effect of deflation on government finances. With falling sales and more caution on the part of indebted consumers struggling to service their debts, national GDP will shrink. Thus the debt-to GDP figures will increase. Just ask any ordinary Greek what this scenario will feel like.

Investors

For investors in such a scenario, it makes sense to steer clear of some of the behemoths exposed to the consumer side and instead invest more in high growth small caps – although this is an area where you need to take extreme care.

Remember: cash is King, Queen and Prince in a deflationary environment. Its buying power will increase, other things being equal.

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About Author

Christopher Menon

Every Investor Editor Chris Menon is a financial journalist who has written regularly for national newspapers, magazines and websites about personal finance, with particular emphasis on investing.