“This is not to the point of completely unwinding the hard work of the past few decades, but it acknowledges a slight vulnerability. In practice, market-based inflation expectations have indeed seemingly responded to this vulnerability, falling significantly – by between 75 and 100 basis points.
Lascelles does, however, go further to explain why this risk may be overstated, but he concludes “We can explain most – but not quite all – of why inflation is so low. Fortunately, even if the unexplained deflationary pressures persist, total inflation should nevertheless be positive and indeed outright higher than today in the Eurozone, the U.S., the U.K. and Canada. In short, the deflationary trap has not been sprung.”
What it means
James Sullivan, senior fund manager at Coram Asset Management, agrees with Smith’s views and believes interest rates are likely to remain lower for much longer than people expect.
“Central banks have got themselves into a corner and they now have to decide what the best worst outcome is: asset bubbles or halting growth.
He added: “Fundamentally, there is no rationale for central banks to raise rates right now, other than perhaps, a bid to counteract inertia. We witnessed Japan wrestle with deflation and sluggish growth for almost two decades. It’s not an economic dynamic that is easily shrugged off.”
The problem, he explained is that, unless the liquidity created by QE finds the right home, unless banks become confident enough to lend and companies and people begin to borrow, inflation will not be an issue.
As a caveat, however, he said: “With currency wars going on all around, the landscape evolves quickly, and the goalposts shift almost daily – so making a base case for any inflationary outcome at this stage is particularly tricky.
The other problem, of course is the issue of earnings. As BAML points out, at present, corporate asset returns are not being driven by higher earnings.
