Dangers of deflation… and inflation

Unpredictability in the economy is making it hard for businesses to plan ahead, as Clive Lewis, head of SME issues at accountancy body ICAEW, explains.


Unpredictability in the economy is making it hard for businesses to plan ahead, as Clive Lewis, head of SME issues at accountancy body ICAEW, explains.

Unpredictability in the economy is making it hard for businesses to plan ahead, as Clive Lewis, head of SME issues at accountancy body ICAEW, explains.

With consumer price inflation now below two per cent, the immediate concern has got to be deflation. Although a little bit of deflation won’t harm the economy, a vicious circle of falling wages and prices can be extremely damaging, as it increases the real value of debts. There’s a psychological element to this – people are already reluctant to buy anything unless it’s cheaper than it was before.

That said, the MPC has got to be equally watchful when it comes to inflation. We are living in extraordinary times: we have never seen interest rates this low and quantitative easing has never been tried on this scale. There must be a danger this results in inflation, especially when you factor in the size of government stimulus packages.

A worst-case scenario would be the return of inflation without an upturn in the economy. For instance, the pound – which many economists now say is overvalued – might fall sharply, which would create inflation. Or rates might have to be hiked to find buyers for the huge government debt.

Though I don’t expect to see higher interest rates until early to mid-2010, businesses need to be aware of the dangers on both sides. If there is deflation, holding excess stock is a big mistake, but if inflation returns, large stocks are always an advantage. Companies should also secure adequate finance now, and if they can lock in a low interest rate, all well and good.

Nick Britton

Nick Britton

Nick was the Managing Editor for growthbusiness.co.uk when it was owned by Vitesse Media, before moving on to become Head of Investment Group and Editor at What Investment and thence to Head of Intermediary...

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