Who benefits from lower inflation?

19th January 2012

This has some pleasing knock-on effects. Not least, it makes a rise in interest rates unlikely for the foreseeable future and many are now predicting no rise in rates until 2016 at the latest. But who are the real beneficiaries of lower inflation? Which parts of the economy should see stronger growth now that inflationary pressures have eased?

First – and perhaps most important – is the consumer. There are, of course, all sorts of other pressures facing the consumer, but lower inflation will put more money in its pocket.  

"We're going to see inflation drop very sharply over the next six months, which is quite good news from the point of view of the broader economy in terms of supporting consumer spending," said David Tinsley, chief U.K. economist at BNP Paribas SA in London.

This is both cause and effect. It is falling prices on the high street that have pushed inflation lower : Ranvir Singh, chief executive of market analyst RANsquawk, believes the "ruthless price cutting" on the high street is to thank for the falling rate of inflation: "Today's figures are of course welcome. But with most economists predicting further stagnation or even a technical recession in 2012, falling inflation may have little more than a palliative effect," he says. He comments that with weak consumer demand, the pressure to keep prices down will continue, citing the recent price cuts from the 'big six' energy suppliers as evidence.

There are also corporate winners and losers from lower inflation. Companies with weaker pricing power, who found themselves unable to pass on higher raw materials prices will see some reversal in fortune. For example, this piece from 2010 shows the pressure faced by some companies from high input prices: 

The vigour of the latest surge in input costs has taken some by surprise. John Bason is chief financial officer at Associated British Foods, which apart from its business in sugar and groceries also owns Primark, the European discount retailer famed for its £2 T-shirts and £5 trousers. That gives Mr Bason a 360-degree window on input inflation. "It's much more of an issue than we thought in the summer," he says.

Equally, there are those companies for whom inflation had provided a boost -such as commodities companies – who will now face a tougher time. This piece in the Huffington Post said that inflation had proved healthy for a number of areas:  "First, about commodity companies…In particular, petroleum companies (i.e. Anadarko Petroleum: APC), coal producers (i.e. Alpha Natural Resources: ANR, Arch Coal: ACI), aluminum handlers (i.e. Alcoa: AA), and even uranium suppliers (i.e. Cameco: CCJ) persistently rise following increases in inflation.

"Then, there are the financial services companies like the Bank of New York Mellon Corp. (BK) and American Express (AXP) that statistically benefit from rising inflation. How so? The simplest explanation can be found in the lending rates of these firms: with higher inflation, the banks tend to charge higher nominal rates from their customers, capturing a larger spread between the rates at which they lend and the rates at which they borrow." This advantage will disappear in a climate of lower inflation.  

Pension funds are other unlikely beneficiaries, which should in turn benefit companies such as BT or British Airways, with large defined benefit schemes to support :  "The typical FTSE 350 company has been allowing for RPI inflation to run at 3.5% p.a. and CPI at 2.8% p.a.. If RPI persisted at over 5%, FTSE 350 companies would need to find an extra £7bn to meet the higher costs."

However, amid the positive benefits of lower inflation, Daniel Knowles in the Telegraph asks whether lower inflation will ultimately be paid for with higher unemployment. He shows the relationship between the two statistics:  "the Office for National Statistics revealed that inflation has fallen to 4.2 per cent, from 4.8 per cent in November …This morning, they have published the exact corollary: unemployed has increased by 118,000, reaching its highest level since 1995.

His views are not universally supported. MrBishi counters: "Current unemployment is rising because Europe is in recession;  it is difficult to expand the private sector when there's no market for its goods. Inflation – as a consequence of some QE to restart a stalled economy – is not harmful. If the government had said that everyone had to take a 5% pay cut we would have a national strike. 5% inflation achieved the same result with a lot of moaning. Unemployment tends to make people unemployable but we are getting better at reversing this damage."

Overall, the fall in inflation eases pressure on parts of the economy that have faced the biggest headwinds in recent years – the consumer, companies with higher input costs and little pricing power. That it may have been bought at the price of higher unemployment is tomorrow's worry.

 

More on Mindful Money

What can investors learn from innovative failures?

GDP and the illusion of growth

Inflation: Why we’re not “all in this together”

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