Earlier this year inflation was a big worry, now with inflation fading rapidly around the world there is more and more talk of deflation. This note looks at the key issues surrounding deflation, viz: what is it? why it could be a problem? what is driving it? what does it mean for investors? and how likely is sustained deflation? The key points are as follows:

– Global inflation is falling rapidly due to falling oil prices & the economic slump. Next year inflation may turn into deflation, ie, generalised price falls.

– Sustained and uncontrolled deflation would be bad news as it would accentuate problems associated with high debt levels and falling asset prices.

– However, the US Federal Reserve seems to be well aware of the risks and has indicated it will do everything possible to head off a deflationary spiral. It is already embarking on quantitative easing (or “printing money”).

– One outworking though is that government bond yields are likely to fall even lower (possibly towards the record lows seen in the 1940s)

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