ISA Risk Alert: The Threat of Deflation

The Threat of Deflation

Despite the fact that central banks and governments have infused massive amounts of money into economies around the world in response to the coronavirus pandemic, the expected inflationary spike that normally would accompany such moves many not come to fruition, at least not over the near-term.

Instead, deflationary pressures have emerged as a significant threat to many of the world’s leading economies as demand levels have plummeted due to the lockdown measures imposed in an effort to slow the spread of the coronavirus, as well as due to the dramatic fall in the price of oil, gas and other commodities.

Deflationary pressures have long been a major threat to the Japanese economy (since the early 1990s), and over the past decade or so, deflation has also become a major concern for a number of European economies.

Deflation has become associated with wealthier economies that no longer have the means to generate significant economic growth (such as Japan).  As more economies face this prospect, it would make sense for these countries to also face deflationary pressures, particularly if their currencies retain their strength and energy prices remain relatively low.  This points to Europe as the next region most likely to face long-term threats from deflation.

 

The Impact on the Near-Term Economic Outlook

Deflation will remain in place in many economies over the near-term as consumer prices continue to trend downwards due to lower demand.  This will add to the pressure on many leading economies and worsen their downturns in the second quarter of this year.

 

The Impact on the Long-Term Economic Outlook

Inflationary pressures are expected to return in many economies in 2021 as the impact of the massive stimulus measures enacted this year boost asset prices and as consumer demand is expected to trend upwards beginning in the second half of this year.