Low Inflation Low Oil Price Cause and Impact

Published / Last Updated on 16/01/2015

Low Inflation Low Oil Price Cause and ImpactLow Inflation Low Oil Price Cause and Impact.

The Office for National Statistics (ONS) has released data for December 2014 showing that UK inflation fell to an equal record low 0.5% pa.

The Bank of England’s trend (i.e. target) inflation rate is 2.0% pa, so we are 1.5% lower.  Prices are falling dramatically.

What is the cause of low inflation?

Oil Prices: 

The cost of a barrel of Brent Crude has fallen to $45.  This is just a third of the record high price in July 2008 $145.61 a barrel.  So whilst we have not seen petrol station pump prices fall by two thirds, there has still been a fall from the heady heights of around £1.38 per litre (£6.30 per gallon), we are seeing prices falls at the pumps and some are predicted petrol pump prices down a third to below £1 per litre in February.

The United States, the biggest consumer of Oil, is now also the biggest producer of Oil in the World, its fracking programme gathering pace.  This has significantly reduced its demand for imports and combing this with a global economic slowdown, demand for other main producers i.e. the OPEC nations of the Middle East and in particular those countries with instability such as Libya and Iraq, have kept production up as prices falls, to protect revenue.  This is simply supply/demand economic.  Supply is up, demand is lower, prices fall.  This means that daily living costs for us all and also industry have fallen dramatically.

Supermarket Wars:

You only have to turn on your television to see advert after advert for supermarkets competing with each other and making price promises and comparisons.  Tesco has its problems that are well documented and now the discount supermarkets like Aldi and Lidl are majoring on quality of their products at costs much lower than the big brand supermarkets.  We have also seen headlines this week that over 100 supermarket food suppliers could go under due to price reduction demands from supermarkets. This means food prices are falling i.e. inflation is falling.

Inflation Does Not Include Mortgage Costs

Mortgage costs are no longer included in the Consumer Prices Index (CPI) calculation.  This was changed when the Bank of England moved from the old Retail Prices Index (RPI), which included mortgage costs, essentially to try and cut benefits and pension costs as RPI is traditionally higher than CPI.  So CPI is lower anyway.

In simplistic terms, if two of our biggest expenses, i.e. food and power are lower and property costs are not included, it is no surprise that CPI has fallen dramatically.

What is the Risk?  Deflation.

Deflation is the real risk i.e. negative inflation, prices for all goods and services and wages fall.   What this means is that if you could buy your new television cheaper tomorrow than you can today then you will not spend.  Japan had this problem for 10 years.  Japan even resorted to printing “money vouchers” to encourage people to spend.  For 10 years, Japan was in the wilderness, no stock market growth, people not spending and a flat economy. 

This is what both Europe and the UK are worried about.  Europe is the UK’s biggest trading partner and already, Europe is potentially considering an unprecedented move for economic stimulus by using quantitative easing, much in the same way as the USA, UK and Japan has done.

What we expect?

Huge economic stimulus from Europe, UK to keep interest rates low, the USA and OPEC to agree terms on oil production to restrict further prices falls.

Stock markets we expect to be volatile in 2015, much in the same way as 2014, up and down like a “yo-yo”.  2014 saw 15 major shifts in stock market prices, both up and down.  We see 2015 being the same.  This will give all clients the opportunity to react to red, amber and green alerts to switch in and out of markets to make money on their pensions and investments.

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