Thursday, January 16, 2014

The “ogre” of deflation | Our positions in the Aussie and Kiwi are paying off

The big worry for all central banks now is deflation, the reduction in prices for consumer and other goods. Why is this a problem? Those of us who are of an age to remember the days when inflation ran at upwards of 10% per annum on a regular basis, the value of whose savings were wiped out as a result, and who found it impossible to budget or to live without the stress of strikes in support of workers’ demands for their wages to keep up with rising costs, might be a little puzzled about why the reverse situation is a problem.

The answer might lie in the fear that consumers will put off purchases if they believe they can get the goods cheaper at some time in the future. However, the sceptics among us would also consider that, perhaps, the recapitalised banks in many parts of the developed world, which still have balance sheets that are top heavy with debt of one sort or another, would find it easier to deal with this if the effective value of the currency in which the debts were denominated were to decline, which it would do in a higher inflation environment.

The latest star of the global economic scene to raise deflation as an issue is the head of the IMF, Christine Lagarde. At a speech to the National Press Club in Washington she said that central banks had a duty to fight what she termed the “ogre” of deflation. At his most recent press conference, Mario Draghi, President of the ECB, was equally trenchant in his determination to use all means at his disposal to ensure that prices rise at a rate approaching, but not in excess of, 2% per annum.

Today sees the publication of the Harmonised Index of Consumer Prices (HICP), which is the Euro zone measure of inflation across the whole bloc. It also attempts to put in place the kind of adjustments to the figure that is released that would allow for comparison with inflation figures in other major economies, most notably the US, where the methodology for calculating the indicator is slightly different.

The effect of a lower than expected inflation outturn in today’s report, of an annualised rate of 1.20%, will place increasing pressure on the ECB to reduce its target interest rate even further from the record low of 0.75% it is currently at.

Our positions in the Aussie and Kiwi are paying off

We have discussed the prospects for the New Zealand dollar on a number of occasions, and it is heading in the required direction against the Aussie unit for our purposes.

We are also bearish on the Aussie against the US dollar, and last night (GMT) this pair took a decisive step lower on the back of very disappointing unemployment figures from the Australian government.

Right now very little seems to be going right for our friends in Australia. They are in the throes of a transition between a strong mining economy, which sustained them for many years, to one where domestic demand must pick up the slack. This is not easy and there is every reason to believe that things could get worse before they get better.

None of this is helping the Aussie dollar. And then there is the prediction / aspiration of the governor of the Reserve Bank of Australia, Glenn Stevens, that would have the AUD at the level of 85 cents to the US dollar. Taking developments stateside into account, mainly the expectation that the US will end Quantitative Easing, it is looking increasingly likely that Mr. Steven’s will have his wish.

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