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UK experiences deflation – but this could be short lived

This week the Office for National Statistics has reported that UK inflation, as measured by the Consumer Price Index, fell by 0.1% in the year to April 2015 compared to no change (0.0%) in the year to March 2015. This represents the first time the UK has experienced deflation since records began, with major drivers coming from transport services, namely air and sea fares, exacerbated by the timing of Easter.


This looks likely be a temporary blip and it is worth pointing out that Retail Price Inflation remains positive - albeit low - at 0.9% over the same period. The evaporation of inflation this year has in large part been a result of the significant decline in the oil price since last summer as the Saudis have increased production to squeeze the US shale oil industry. However, the oil price has rebounded 40% off its January low so if anything in the short term the markets have started to worry about the return of inflationary pressures, which appears to be a factor in the recent spike in yields in the global bond markets, especially German bunds.

That said, looking further out the rally in oil and other commodity prices may itself prove overdone. There is a big mismatch between supply and expected growth in demand for oil, with the US Energy Information Administration recently estimating global oil demand will grow by just 1.3 million barrels a day next year, way below the 2.89 million level seen in 2010 after the last significant oil-price slump – a pace of demand growth that won’t absorb the overhang in supply given the soaring output from Saudi Arabia.  With talks continuing to secure an agreement to limit Iran’s nuclear ambitions, a final agreement this summer could also see a material increase in Iranian supply to add to the current over-supply.

And then there is China, which continues to grapple with a structural economic slowdown and attempts to shift its economic model away from credit-financed, commodities-intensive infrastructure development, in favour of growing the Chinese consumer market and service sectors. That should lead to continued weakness in the prices of many resources and when combined with the release of excess inventory by China, this risks exporting deflationary pressures around the globe.

On balance therefore, while deflation looks like it will be temporary and in the near-term inflation should rise, when you look through all of this, the inflation outlook is benign.

The value of your investment can go down as well as up, and you can get back less than you originally invested.

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