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When oil prices began to slide last June, bringing global inflation down across the world, economists faced a conundrum.
Lower price pressures were meant to raise disposable income among consumers, encouraging shoppers to spend, boosting economic growth. An alternative scenario, however, would see families holding back from opening their purses in the hope of even lower prices in the future. Economies would then suffer the plight of Japan, which has remained stuck in deflation for nearly two decades.
The halving of crude prices since the summer has brought US and eurozone inflation below zero. Prices in the UK are rising at the slowest rate in decades. Even in Japan, where the central bank’s programme of quantitative and qualitative easing had succeeded in pushing up inflation, price pressures have come down sharply compared with last spring.
But despite pessimists’ predictions, there is little evidence of a negative spiral of falling prices and weak demand tainting the world economy. Indeed, in January, annual retail sales in the world’s most advanced economies rose at their most rapid pace since 2006, according to Capital Economics, a consultancy. Sliding oil prices have put $250bn in the pockets of consumers in these economies and shoppers seem determined to spend it.
The bounce has been steepest in the UK, where retail sales have risen, on average, by 5.2 per cent year on year in the four months to January. But the resurgence has been nearly as powerful in the US, with a 3.9 per cent increase over the same period. And while US retail sales growth in December and January was somewhat disappointing, the recent strengthening of the labour market suggests activity may have rebounded in February, with Morgan Stanley forecasting a 0.5 per cent month-on-month rise.
The most remarkable jump has taken place in the eurozone where, after years of stagnant growth and sky-high unemployment, the currency union faced the risk of a Japan-style lost decade. But consumers seem to have shrugged off some of these fears. After rising by a healthy 1.5 per cent in October and November, retail sales accelerated even faster in the following two months, growing at an average annual rate of 3.4 per cent.
Eurozone retail sales were buoyed in January by German sales jumping 2.9 per cent month-on-month and 5.4 per cent year-on-year. “The fundamentals for German consumers are particularly healthy given high employment and pronounced real wage growth,” said Howard Archer, an economist at IHS Global Insight.
For now, there is also little evidence that falling prices are feeding into wage negotiations, which would make deflation harder to overcome. The average bargained wage across the eurozone grew 1.69 per cent in the last quarter of 2014 compared with a year before, according to European Central Bank data. While this is at the lower end of the ECB’s inflation target of close to 2 per cent, it is marginally higher than the level registered in the third quarter.
For months, a bigger concern for policy makers was the slide in expectations of future inflation. But the ECB decision to launch a programme of quantitative easing, which will begin on Monday, has helped reverse the trend.
Across the rich world, the country which seems to be benefiting the least from this bout of slowing prices is Japan. While wages are finally showing signs of picking up, with basic pay growing at the fastest rate in 15 years in January, there is little evidence shoppers are spending the windfall from sliding oil prices. Retail sales fell 1.3 per cent in January compared with December and consumption was predicted to fall sharply next year.
With oil prices stabilising and even making up some of the lost ground, the slide in inflation is likely to come to an end in the coming months. This puts the question of when to raise interest rates back on the table at the US Federal Reserve and the Bank of England. The US and UK central banks have been shielded from having to tighten monetary policy by an inflation rate that has remained well below their targets.
The biggest puzzle could well be the one facing the ECB, which now expects inflation to bounce back from zero this year to 1.5 per cent in 2016. The central bank has promised to buy €60bn worth of government bonds and other securities a month until inflation is on track to hit its target.
Were the recovery to gather steam even once the effects of low oil prices have faded, Mario Draghi and his colleagues may have to ponder what just a few weeks ago looked truly imponderable: bringing their programme of quantitative easing to an end months before they originally intended.
Not even the most optimistic economist would have predicted that.