Deflation – what does it mean?


It has been announced today that the UK is officially in ‘Deflation’ or negative inflation as it is sometimes referred to, but what does it mean and how may this impact on you?

Deflation is a decrease in the general price level of goods and services and occurs when the inflation rate falls below 0%. So, what could be wrong with that I hear you ask yourself? We’re all happy when goods are cheaper, right? True enough yes, but deflation can cause damaging consequences to the economy which in turn can pass on to us.

One example of a problem caused by deflation is that the real value of debt grows. If you have £500 in debt, and prices are falling at 1% the bank you owe the money to won’t suddenly reduce your debt to £495, your debt is still £500, so the ‘real-value’ (the inflation-adjusted value) of the debt has just gone up.

Deflation is just as damaging for businesses, if they owe debt, they may reduce investment, lay off staff, keep employees’ wages lower or worse case scenario cease trading.

Consumer confidence can be reduced at this time amid concerns about the economy and this can often see individuals begin to spend less.

An example of deflation and it’s effects can be seen when you look at Japan from the beginning the early 1990s. Japan went through periods of very low inflation, then into deflation, then very low inflation again, then into deflation. Over that period, there has been very sluggish economic growth in Japan and in turn disappointing stock market performance.

If you look at the interest rate, currently 0.5%, and prices are falling, in reality this means that interest rates are higher than they look to be at first glance.

So, is it all bad news? Of course not. Life is all about balance, and whilst it may not be good for those with debts, if interest rates are lower for longer, this is good news for the stock market which in turn, is great news for investors!

If you’re interested in investing or you’d like an appointment to see a Financial Adviser, simply get in touch and we’ll get back to you as soon as we can.

Where did you hear about us?