"Britain faces deflation for first time since 1960"

What is remarkable about this forecast for deflation is that, unlike the US, which just posted flat consumer prices in September, the UK’s recent inflation reports have still been in strong positive territory. Just as its housing market went into a sudden downdraft, Britain’s retail prices are projected to go sharply into reverse.

From the Telegraph:

For the first time since 1960, the cost of living will start to shrink next year, in a worrying parallel of the Japanese “disease” of the 1990s, according to new research.

The news comes amid growing speculation that the Bank of England will soon be forced to cut borrowing costs to 2pc or below, taking them to their lowest level since it was founded in 1694… there is also growing evidence that inflation, which has risen above 5pc in recent months, is set for a dramatic fall. The Retail Price Index – the most comprehensive measure of UK high street prices, will drop at an almost unprecedented rate to -2pc by the second half of next year, according to new research from Fathom Consulting.

It said the fall was largely due to the drop in mortgage costs and house prices, which together form a large part of the RPI. However, lower food and energy prices would also play an important role. Since modern comparable records began in 1956, the RPI has dropped into negative territory only once, in the late 1950s and early 1960s, but it only dropped as far as a rate of -0.5pc.

Andrew Brigden, economist at Fathom Consulting, said: “This does have worrying implications – particularly if it heralded a general period of deflation. The risk is we have a rerun of Japan because you simply can’t [cut interest rates] to below zero.”

Japan suffered almost a decade of deflation and falling economic growth in the 1990s after its debt-fuelled economic bubble burst with painful consequences. Despite cutting official interest rates to zero and pumping cash into the economy, the Bank of Japan was unable to pull prices back up into positive territory for years. However, Fathom predicts RPI will drop below zero for only a few months.

Whereas high inflation tends to encourage borrowing, deflation encourages saving and, as a result, discourages companies from investing and spending today what they could save for tomorrow.

Fathom’s prediction is based on the assumption that the Bank of England cuts interest rates to 2pc within a year. Although markets anticipate borrowing costs falling to only 3.5pc, a growing cohort of economists think it will be forced into taking more drastic action. Mr Brigden said if oil prices came back below $70 a barrel and house prices fall at an even faster rate, the level of RPI inflation could fall as low as -3pc and remain in negative territory for a year.

Although Fathom does not expect the Consumer Price Index – the measure targeted by the Bank’s MPC – to drop into negative territory, Prof Peter Spencer, of the Ernst & Young Item Club, said such an eventuality was not out of the question.

“This time next year we’re looking at all of these huge increases in bills coming out of the index, and then potentially falling,” he said. “CPI will go viciously negative – it’s looking increasingly likely that it drops below target. It could easily go into negative territory, along with RPI.”

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  1. doc holiday

    Re: "The risk is we have a rerun of Japan because you simply can't [cut interest rates] to below zero."

    >> Oh sure you can, you just have to adjust the yield curve to be realistic and not expand it just forward. Elasticity baby, get real and be flexible, more dynamic and less old fashioned. The English are so dull!

    This is simply not the time or place to go into this, but The Yield Curve is not built on solid ground.

    See: The main disadvantage is that, under Vasicek's model, it is theoretically possible for the interest rate to become negative, an undesirable feature. This shortcoming was fixed in the Cox-Ingersoll-Ross model. The Vasicek model was further extended in the Hull-White model.


    The drift factor, a(b − rt), is exactly the same as in the Vasicek model. It ensures mean reversion of the interest rate towards the long run value b, with speed of adjustment governed by the strictly positive parameter a.
    The standard deviation factor, , corrects the main drawback of Vasicek's model, ensuring that the interest rate cannot become negative. Thus, at low values of the interest rate, the standard deviation becomes close to zero, cancelling the effect of the random shock on the interest rate. Consequently, when the interest rate gets close to zero, its evolution becomes dominated by the drift factor, which pushes the rate upwards (towards equilibrium).


    Oh bloody hell, I'm going below zero and the hell with some fake ass standard deviation, see:

    Louis Bachelier

    See: Brownian motion (named after the botanist Robert Brown) is the random movement of particles suspended in a liquid or gas or the mathematical model used to describe such random movements, often called a particle theory.
    The mathematical model of Brownian motion has several real-world applications. An often quoted example is stock market fluctuations.

    See: Yves pulling her hair out….

  2. doc holiday

    One last point, related to yield curve construction and our universal journey beyond zero:

    A Cyclic Universe
    Does the universe repeat once every trillion years?

    Roger Penrose has argued that a cyclic model may be necessary to explain how the universe is compatible with the second law of thermodynamics, one of the most fundamental dictums of physics. According to the second law, entropy (the amount of disorder) always increases. Since the inflationary model creates an enormous amount of entropy, the universe must have begun with very little before inflation. However, there is no explanation for why this should be so. In fact, cosmologists often describe the universe right after the bang as being chaotic and random, suggesting high entropy. Penrose argues that some event must have preceded the bang to make the entropy low and that this event is likely to repeat in the future. Coming full circle, this seems to result in a cyclic universe.

    See: Ekpyrotic and cyclic models that can be described in terms of the ordinary fields (like yield curves?)

  3. Anonymous

    I’m loving deflation. Cheaper houses, cheaper gas, cheaper cars, cheaper watches… woo hoo! It’s the government that I’m worried about.

  4. Anonymous

    We may have deflation in the short term, but this is not Japan. The bank debts are more than our GDP. This cannot all be serviced by taxation or borrowing, so the monetary printing presses will have to be run at full speed. The pound will be devalued in real terms by at least a third, giving strong inflationary consequences from next year onwards.

  5. aw70

    Deflation is *not* necessarily bad news on all fronts.

    As far as anecdotal evidence goes, I can offer the following: both myself and several of my friends – professional mid- to end thirtysomethings, who are living in western central Europe – are sitting on cash savings.

    Up to now, most of us were reluctant to spend that on the kind of large price tag items that make the economy tick (such as new housing), simply because the price increases of the last 10-15 years had left us sort-of well off people with real money in their hands out of the loop. Normal people with normal incomes cannot afford real estate anymore here, at least not without the help of loans. Which is really insane, if you think about it. If you are sitting on the equivalent of several year’s salaries worth of savings, it should buy you more than a hovel.

    That having been said, none of us felt like getting a loan to buy a new flat or house recently; we all have our current living arrangements, and while getting a larger flat or house would be nice, none of us fiscally responsible persons felt like getting a loan was worth it in terms of added complexity and tie-downs in our lives. Especially since we all felt that current real estate prices are massively overvalued anyway, so we would not be acquiring real value by such a transaction (!).

    Enter deflation, and falling house prices.

    This is not going to cause a stall in the real estate market, and not in any of the other markets as well. At least in Europe, there are enough people sitting on savings who are biding their time to come out of the woodwork. There is just going to be a switch in who is in the market, but both the money and the motivation are there to continue (and probably increase) trading during a deflation phase. This is probably the key reason why everyone in Europe is so adamant about keeping the banks and all those savings accounts alive – they are the lifejacket of the economy during the coming slump.

    The only ones who are going to get burned are real estate speculators, but these chaps are usually bottom-feeding vermin anyway. The gene pool can do very well without them.

  6. Jojo

    @aw70 said “Enter deflation, and falling house prices.”

    Yes and also falling employment and failing businesses. Businesses don’t grow when anything they buy to manufacture products is worthless next month than this month. Stagnant businesses mean they need fewer employees.

    Consumers don’t buy because they believe they will be able to get the same product for less in the future.

    And just to make sure we are on the same page, deflation is a contraction in credit. Falling prices are an effect of the credit contraction.

    So you can buy a house cheaper? When are you going to buy it? Will you still be happy if it is worth less than you paid for it 3 years hence? How about all the people who already own homes that continue to drop in price each month? Are you employed? IN deflation there will a lot more people to compete with for employment if you should lose your job (and then how will you pay for that house you brought whose value is declining each month?).

    No, deflation isn’t pretty nor the cakewalk that you seem to be envisioning. This is why governments fear deflation much more than inflation.

    Suggest you Google “effects of deflation”.

  7. Richard Kline

    So Anon of 3:00 AM, cheaper sex workers, too; several artilces on that, which is a trailing indicator of how some journalists spent their time, who their friends are, or both. I’m just sayin’ . . . .

    Bear in mind that ‘deflation’ is not a bananna, it’s a bunch of asparagus. That is it isn’t a unitary phenomenon with a single vector of effect. We will have at least: 1) asset price declines; 2) credit availability declines with, in this case, attendant increases in credit costs; and 3) contraction of economic production due to lost investments, inventory distortions, increasing credit costs, and demand decreases. We likely will _not_ have declines in the overall money supply, but credit contractions have similar if not equivalent effects. —But are all of these ‘deflationary?’

    Asset prices have been wildly excessive, and they have not yet declined below long term trends, so their declines may not properly be considered deflation, yet. And their declines are good things in many respects from a macro viewpoint, just as the West European normal chap above observes rightly. Credit contraction is unquestionably deflationary in effect. We will see an all out effort by public authorities to fight this, but they are not being very smart about _where_ they are trying to get credit advancement going again. Economic output declines are deflationary past a certain point; we likely will pass that point.

    Just bear in mind, not all deflationary vectors are created equal, nor do they impact the same wallets in their direct impacts. In aggregate, we may all be weighed down, but in component some will benefit with the right variables of income (stable) and debt (low).

  8. EvilHenryPaulson

    I vehemently disagree that inflation/deflation is a problem beyond currency stability such that it remains useful between 2 transactions. Deflation is merely a symptom and treating it literally is akin to fighting a fever with bags of ice.

    Whenever there is talk of the Great Depression or Japan's lost decade, the problem is encumbered individuals and institutions.

    What is more logical:
    • a bank not lending because there are no returns available above cash OR a bank not lending because it has an overhang of debt
    • an individual not consuming at previous rates of consumption growth because they are hoarding cash OR they can't get credit and the positive feedback loop of credit -> wealth generation is shut down

    Japan is a very unique situation in many ways. It's credit + wealth generation feedback loop was broken by the time the government tried to inflate the currency and as a consequence that excess currency was instead absorbed into the carry trade.

    If global trade/investment slows down it will hit Japan as a heavy exporter, but may serve to raise growth internally if that excess currency does return home and does get into the cycle of domestic lending and borrowing (which we'll have to wait to see for the Japanese are very cautious about saving for retirement, and it is also a hurdle to jump into increased consumption during an economic downturn)

  9. Matt Dubuque

    For some reason it is extremely difficult for Americans to accept the notion that hyperinflation is not immediately around the corner. Europeans get it. But Americans, as a whole, can’t seem to master the concept. They just view the gathering risk of a deflationary burst as a metaphysical impossibility. It’s apparently a belief held with deep religious intensity stateside.

    Perhaps a spanking Depression will disabuse them of this notion. Perhaps not.

    Now, as I predicted a seven weeks ago to generalized disbelief in this forum, the collapsing price of gold is beginning to reflect this growing danger.

    This collapse in the price of gold brings it into line with the collapse in the price of real estate, with the collapse in the price of copper, with the collapse in the price of oil, with the collapse in the price of the CRB index, with the collapse in the price of stocks, with the collapse in the price of corporate bonds, with the collapse in the price of emerging market debt and much more.

    A deflationary burst cannot simply be “reflated” away, mistaken comments by Bernanke to the contrary. The complete liquidation of the world’s financial system, which could well occur, is not easily reversed.

    Matt Dubuque

  10. Anonymous

    The surging dollar currently points to deflation with its appeal to cash over assets. As Richard pointed out deflation has many faces but the most at risk are those exposed via leverage. This seems for momument to be the key and will be the driver in the financial culling taking shape. The financial sector has relied on leverage to keep it from being the commodity business it really is but the excessive credit leverage creation has run its course and with it will comes the realization that a gov’t can’t replace this method of GDP spiking and get down to the business of creating a tax and spending plan beyond just special interest imput.

  11. Anonymous

    I guess we will eventually see whether a deflationary burst can be reflated away or not in a country with the world’s reserve currency. I’m not confident enough to bet either way on that question. What I think is much more certain is that the US **will try everything** before giving up on reflating. So if they fail, that would be pretty solid evidence that it was not possible.

  12. Anonymous

    “Consumers don’t buy because they believe they will be able to get the same product for less in the future.”

    I really wonder if that argument is really true. The prices of computers and many other electronics devices have been coming down for a while now. Did people stop buying them? Did that cause a depression in the computer industry?

    Japan is a widely cited example of the bad effects of deflation. Do we really have a causal relationship between price depression and the Japanese recession?

  13. Blissex

    «Oh bloody hell, I’m going below zero and the hell with some fake ass standard deviation, see: Louis Bachelier»

    Ah, {doc holiday} that’s a bad reference. Bachelier style gaussian based models seem to be part of the reason we are all in trouble.

    Mandelbrot’s “The misbehaviour of markets” has lots and lots of arguments against gaussians and Bachelier (as well as a nice history of his work anyhow).

    Much the same arguments are used in Taleb’s “Fooled by randomness”.

    And never mind the terrible problems with assuming uncorrelated or anticorrelated gaussian/brownian motions, which is what most risk modelers were very well paid to do.

  14. Tortoise

    Three remarks:
    1. CPI deflation is often predicted. But CPI inflation very seldom appears. There are just too many political forces aligned against CPI deflation.
    2. Deflation (like inflation) has winners and losers. So to write “Japan suffered almost a decade of deflation…” just reveals the author’s bias. Deflation is not bad for the economy at large, except perhaps in the short term. In the long term, the average person may in fact benefit from deflation.
    3. Japan allowed deflation because Japan wanted to remain competitive as an exporter and wanted to maintain a high real savings rate. Germany has found other ways to keep inflation low, even without control of their monetary affairs: They discourage speculation on land though regulation and tax policy.

  15. Tortoise

    Obviously, in my previous comment I meant that CPI DEFLATION very seldom appears.

    I strongly believe that how much inflation/deflation we get is a political decision. My libertarian friends expect deflation (the “pushing on a string” argument). However, in state capitalism, the government and the central bank can always waste enough money to create inflation.

  16. doc holiday


    Perhaps my reference to zero there needs a nudge, but there is something about Mandelbrot that has me on edge — there is something in the back of mind that I can’t get to.

    In the meantime, as I wait for intervention:

    Mandelbrot sets are bounded complex numbers and thus Brownian crap seems more dynamic, as in randomized chaos.

    “In probability theory, the inverse Gaussian distribution (also known as the Wald distribution) is a two-parameter family of continuous probability distributions with support on (0,∞).”

    I need time, damn it… please give me more time…

  17. Anonymous

    @jojo, during deflation:

    1) Consumers generally do not delay purchases of items just because the price will be cheaper in the future. They want their stuff now. And because their money goes further, they will likely be patronizing more, not less, businesses.

    2) Many businesses will benefit from lower costs. Cost savings can be passed on to consumers and/or used to grow the business.

    3) Businesses that thrived on high leverage and mis-allocation of resources will likely fail. Freed up resources will be better put to productive use.

    4) Deflation is a contraction of the money supply, one component of which is credit. Falling prices would be a likely consequence of deflation. And as pointed out above, this is a welcome consequence.

    5) Once you drive out the over-speculation brought about by bad central bank policy, housing prices will settle (as they are traditionally stable). People can buy when fundamentals are back to normal. They can then rest assured that they have a sound nest egg for the future.

    6) There will be an adjustment of dislocated resources. This means there will be hardship for some. But the economy as a whole will be improving and therefore will offer these people new opportunities.

    7) Deflation is neither pretty nor ugly nor a cakewalk. It’s just a necessary adjustment. It is the reallocation of resources. It is brought about by years of bad monetary policy that was unsustainable by definition.

    8) Governments thrive on inflation because it allows them to transfer wealth away from the public. It should be no surprise then that they fear deflation. However, they fear for their own well being, not for the public.

    I suggest you google some more.

  18. doc holiday

    Fractional Brownian motion denotes a family of Gaussian processes that have continuous sample paths indexed by the Hurst parameter H ∈ (0, 1) ..
    .a continuous-time Gaussian process starting at zero, with mean zero, and having the following correlation function…. no, that was close, but, no…

    >> I'm still thinking on Mandelbrot , but the problem here with many of these models, is that the quant geeks take a snap shot of events in "real time" and then dream up correlations to fit models that are based on dreams, versus the reality of dynamic events. Obviously these Playstation children with attention deficit disorder want to look at colorful screens and play with interactive relationships, but every time they play the game, they are locked in a game that has limitations, yet they claim they are working with dynamic data that provides continuous connectivity to the system. This is like having a Playstation game, then getting a daily upgrade, which is based on more old data, which is not in the old model, and so this additional model information for some reason validates the model as a predictive tool which will provide information about future events. Obviously, our Attention deficit zombies, who are busy playing with this weeks model version, think they have a model for next week, but as with any kid, they have to re-learn the old model and adjust to old information that has no relationship to the challenges of the version to be released 8 weeks from now.

    Ok, put another way, this is like having a Power Point presentation or slide show, or a satellite feed that provides a record of past events, like cars on a highway over a 24 hour period. These gurus think they can account for all the future traffic flow of the event in front of the camera, and so, they extrapolate that fractional section, then tell you they understand all the traffic within the system.

    I don't have time for this shit, and Yves is already going bald from pulling her hair out, over posts like this, so, maybe when I remember "that thing" about Mandelbrot, I'll send a chart, which will be worth a thousand words…

    I'm sorry…

  19. FairEconomist

    The fact that the Brits (and others) are trying to fight deflation with central bank interest rates cuts is a lot of the problem. We need (some) expansion to the money supply, and the interest rate cuts signal an intent rather than actually doing it. The governments need to step in directly with open market operations. Then they need to keep real interest rates high so the money stays in their economy and doesn’t get carry traded away. Fighting deflation with interest rate cuts leads to Japan’s situation – weak money supply growth, continued deflation, and a carry trade sucking away the money they manage to create.

  20. Blissex

    «Then they need to keep real interest rates high so the money stays in their economy and doesn’t get carry traded away.»

    Problem is, even without handing over free money, investor find that investing in China is still a lot more profitable; or investing in commodities or the other bubble of the day.

    «Fighting deflation with interest rate cuts leads to Japan’s situation – weak money supply growth, continued deflation,»

    But the fundamental cause of Japanese deflation is that its population and economy are shrinking. For the USA and the UK it is not the same — it is that they bet on financial services as their export leading sector, and sent to China and India a lot of the rest. Now bad news.

    «and a carry trade sucking away the money they manage to create.»

    I sometimes suspect that the carry trade was a policy too, to create large foreign assets for an ageing population. Or perhaps it is just the BoJ was insane.

  21. Anonymous

    In sync with remarks by Andrew Lahde, “…The low-hanging fruit, i.e. idiots whose parents paid for preschool, Yale and then the Harvard MBA, … rose to the top of companies such as AIG, Bear Stearns and Lehman Brothers and all levels of our government.

    “All of this behavior supporting the Aristocracy, only ended up making it easier for me to find people stupid enough to take the other sides of my trades. God Bless America.”

    This is a scheme in place for at least a decade to skim everything bit of wealth from this country, support an elite and leave the rest of us to compete with India, Mexico and China for jobs.

    One of the reasons Lehman was left to bankruptcy was because it was cheaper for competitors to hire the executives.

    But there is so much more to this story that we should be paying attentoin to.

  22. Yves Smith


    As far as I can tell, you are partly right.

    Japan’s contracting economy and population are linked phenomena. Although most advanced economies have birth rates below replacement levels, Japan’s is one of the lowest. That is at least in part due to lousy growth (the other, IMHO, is that women have better, although still not great, work opportunities, and sex roles have not changed one iota. So young women don’t see marriage as particularly attractive).

    Growth is a function of productivity increases and demongraphic growth. It is possible, but admittedly unlikely, to have economic growth with a slightly falling population.

    From what I can tell, the carry trade was encouraged (banks were permitted/encouraged it easy for retail investors to put their money overseas) because domestic investments provided little current income. So yes, they institutionalized the carry trade.

  23. Tortoise

    On Japan’s demographic issue (not problem):

    Japan has a low birth rate BUT ALSO discourages immigration into Japan. This is an important distinction from some European countries with stable or increasing population due to liberal immigration or immigrant-toleration policies. (Of course, counting immigrants is a hard job as many immigrants are illegal. However, in relative terms, there seems to have been less immigration into Japan than into the UK, The Netherlands, Spain, Italy, etc.)

  24. Anonymous

    Blissex said

    Or perhaps it is just the BoJ was insane.

    Reading the FT article on Tokyo ‘floaters’ this looks to be rather too close to the truth for comfort.

  25. Adam Smith

    Prepare for the New World Economic Order

    Interest Rates [Credit] are the Cause and Consequence of the Explosion of Income/Wealth Disparities and, Hence, of the Inherent Instability ofthis Economy:

    The Ominous Keynes’ Liquidity Trap.

    Everyone Need an Economy, Don’t They?

    There Is One Solution That Works:

    A Credit Free, Free Market Economy:

    The New World Economic Order.

    The Only Goal of 1776 – Annuit Cœptis is to Implement It.

    They Can Transfer Their Assets & Forget Their Liabilities.

    Anyone Can Join But Still Needs to Ask for It.


    The Purpose Is to Provide Both a New Deal and a New Game.

    It is NOT to Fix This Economy Which is Already Beyond Repair.

    The Intention Is to Create a New Economy
    With the Assets of the Old One Without its Liabilities.

    Why Not Insure Against the Worst Case Scenario?

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