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20th May 2015

A look at deflation and how it can affect your investments

In April 2015, the UK Consumer Prices Index (CPI) inflation turned negative for the first time since official records began in 1996 and the first time since 1960, based on comparable historic estimates.

According to the Office for National Statistic (ONS), CPI fell to minus 0.1%. The largest downward contribution came from transport services – notably air and sea fares, with the timing of Easter a likely factor.

So what is deflation?

Deflation is the opposite of inflation. It is a word used to describe a situation where the general price of goods and services are falling. What costs 100p today may cost 99p next month.

Is that a good thing or a bad thing?

For a short time, deflation can be very welcome, as consumers can buy things more cheaply, and it can encourage people to go out and spend. However. it can be a problem if prices fall for a long period of time. The example always cited is Japan, where they had a deflationary environment for two decades!

In this scenario, instead of just putting off a purchase for a short time, people stop buying at all if they can and they stop investing as the price of assets keeps falling too. That is extremely bad for an economy. It means company profits fall, wages fall and people lose their jobs. The knock on effect for investments is that as profits fall, share prices and returns to investors also fall.

What does deflation mean for your investments and savings?

Whilst generally a bad thing for many companies, some that have pricing power, either through their brand names or position within a sector, can usually ride out a period of deflation quite well.

There are also some sectors which have grown to live with deflation and still do well. For example, technology. We all know that the price of computers and phones have fallen considerably and still do – as soon as they are bought. But the sector has adapted and thrived all the same.

Deflation is also good news for those on fixed incomes, as falling prices means their money goes further.

So, deflation has many negative connotations, but as long as it is short-lived, it should not become something we should be worried about.

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