The U.K. Could Suffer A Bout Of Deflation Much Worse Than Anything Till Now

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by: Thomas Paterson

This week Posen of the BoE has been spouting the virtues of money-printing to anyone who’d listen, whilst claiming that inflation was ‘transitory’ and the real threat was deflation (you may have read my previous recommendations to buy gold on other gold news websites as a more well grounded investment).

So we thought we’d take a look just how far above its 2% inflation target the BoE has got and more importantly, just how much deflation would be needed just to get back to where the BoE should be if it was hitting its 2% target. The results even surprised us.

At the moment the BoE’s annual inflation target is 2% as measure by the CPI - or to put it another way the BoE should be targeting a monthly rise on the CPI of 0.1667% each and every month (0.1667 x 12 months = 2%).

We have to go all the way back to November 2009 (yes that far!) when the BoE was last around target. So we’ve used November 2009 as our base month and simply plotted a 0.1667% monthly line to show where the BoE should have been.

BoE on target

So that’s where the BoE should’ve been - but in reality we got this:

What the BoE has achieved

So after 22 months total inflation for that period, if the BoE was ‘on-target’, should add up to 3.5%. Instead what we find is that is that the BoE has generated over 7% inflation over that time-frame. Or to put it another way, the BoE has generated 3.5% more than otherwise would have been generated if the BoE was simply doing its government mandated job of hitting 2% annual inflation. Simply put, the BoE has produced more than 100% extra inflation than it should have.

Now this is where it gets interesting - how much deflation in the economy would it take just to bring the BoE back to where it was meant to be all along?

Let's suppose the BoE generates 0% inflation every month from here on, how many months would it take to get back to target?

zero percent inflation

That’s right, the economy could experience 0% inflation and it would take all the way until June 2013 just to be where it should have been.

Ok, now let's suppose that we see deflation in the economy of -2% annually (-0.1667% per month). How long to get back to target under that scenario?
minus 2 percent inflation

Yep, even with a 2% annual fall in inflation it would take until July 2012 just to get back to the government mandated target.

And finally, let's see how much deflation would be required in one month to get the BoE back in line with where it should be:
43 percent annualized will get the UK back where it should be

It would require a monthly print of minus 3.59% or minus 43% annualised just to get back to the place where the BoE should have been all along.

To put this in context the biggest one month fall the UK experienced was -1.4% back in December 2008, right at the height of all the ‘deflation’ worries - in fact on an annualised basis the CPI has not even been close to being negative - the lowest yearly print was plus 1.1% back in September 2009. During the entire crisis on a yearly basis we haven’t had a print lower than this.

To put this altogether, the UK could suffer a bout of deflation way worse than anything we have experienced at the top of the financial crisis. All this would do is put the UK back on track to where it should have been if the BoE had kept its 2% CPI target in the first place.

The idea that deflation is such a threat when all it means is the BoE getting back on target just goes to show you what a complete myth this deflation specter really is. The plain fact is the BoE and the government positively need inflation way above their 2% target to wipe away the massive debt overhand, but they have to hold up this false demon in deflation to scare/fool the people into accepting it.

Don’t be fooled - more money printing in the UK is coming in October/November and the debasement of the pounds in your pocket will step up a gear. The only question you have to ask yourself, are you going to let them?

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.