Economists tip falling CPI but healthy economy means this will be a positive for consumers and New Zealand

Talk of deflation in some parts of the world has grown over the past few weeks.

A December report showed that the eurozone consumer price index (CPI) fell 0.2 per cent from a year earlier. This was the first time prices had turned negative since the height of the global financial crisis in 2009.

Closer to home, the highly competent economics team at BNZ are now suggesting that New Zealand will see a falling CPI over the next two quarters, with a real possibility of annual deflation as well.

So what's the problem here anyway? Deflation means falling prices, which is the opposite of inflation (rising prices) and at first glance, that doesn't sound too bad at all. Goods and services getting cheaper, our cost of living declining, and more disposable income in our pocket all sound pretty enticing.

Advertisement

In reality, deflation isn't such a good thing for an economy or those who live and work in it. In the 1930s, deflation was one of the things that turned a recession into the Great Depression. Japan has suffered from deflation for the past two decades and this has been terrible for its economy too.

The problem is that when consumers are expecting prices to fall, they delay purchases and stop spending money until things get cheaper. Companies are forced to cut prices to get people buying, but this only reinforces deflationary expectations further. When demand starts to dry up, companies begin laying off staff and the downward spiral continues, towards an ever-deepening recession, rising unemployment and falling trade.

This is the type of deflation that Europe is worried about, given high debt levels, unemployment, low demand and the harsh austerity measures that remain in place.

The United States was in a similar position a few years ago, and its answer was a huge money-printing programme. At the time many people thought this would create massive inflation and while this never eventuated, the Americans probably thought this would be the lesser of two evils anyway.

Don't be surprised if the Europeans follow the lead of the US and embark on their own QE-style money-printing exercise over the coming months.

In New Zealand, we don't need to worry about any such issues. Our economy is growing, unemployment is falling and business activity is ramping up. If we do experience deflation, it will be short-lived and likely to be driven by falling oil prices, rather than economic stagnation.

We will be lucky enough to experience the positives that go with falling prices (higher disposable incomes, lower interest rates and a boost in consumer spending) rather than any Japan-style negatives.

For investors, the types of assets that perform well in a deflationary (or a very low inflation) environment are those that are highly cash-generative. Just as inflation erodes the value of money, deflation sees its future purchasing power increase as prices fall. Cash becomes a safe holding, as do high-quality longer-term bonds due to their locked in cashflows.

Advertisement

In terms of shares, the ones that pay high cash dividends tend to do well, as do those companies that can buck the trend of deflation and incrementally increase their prices anyway. Sectors with these attributes include healthcare, utilities and consumer staples companies.


Mark Lister is head of private wealth research at Craigs Investment Partners. His disclosure statement is available free of charge under his profile on craigsip.com. This column is general in nature and should not be regarded as specific investment advice.