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BLOG: No, we’re not turning Japanese

Written by: Tom Stevenson, investment director at Fidelity Personal Investing
The dip into deflation in April is a landmark – the last time it happened was in 1960 – but no-one should be alarmed. We are definitely not turning Japanese.

In fact, the 0.1% slide in the consumer price index (CPI) is almost certainly going to be a one month wonder. By next month, I expect inflation to be modestly positive again and to continue rising for the rest of the year.

The real concern about deflation is the impact it has on consumer sentiment. People stop buying because they expect prices to be cheaper next year. When this happens, an economy can be caught in a death spiral of slowing demand leading to lower prices leading in turn to slowing demand again.

But Britain is a million miles away from this “bad deflation” scenario. Rather we are enjoying an episode of “good disinflation” – prices are falling because of lower energy and food costs while wages, albeit marginally, are rising.

People are not going to put off filling their car’s tank or doing the weekly shop because prices are expected to be no higher in the future. In the meantime, we all have to eat and drive to work. Instead we will carry on consuming as we always have and just enjoy our money going a little further.

The other reason not to be concerned about today’s 0.1% slide in prices is the fact that it was in large part a statistical quirk caused by the timing of Easter last year and this. With the holiday falling in mid-April this year, many of the price rises occurred in March this time so comparisons looked softer comparing April with April.

Almost certainly inflation will be back to zero or even marginally positive in May. Indeed we are already seeing rises in petrol prices, which are one of the most important drivers of the inflation rate.

The key for individuals is the relationship between CPI and wage growth. At the moment, earnings are increasing at close to 2% a year. That means that wages are improving in real, inflation-adjusted terms. We are feeling richer, albeit only a little bit.

The concern looking forward is that as inflation rises back towards the Bank of England’s 2% target, that differential will narrow. And that means that the Bank’s monetary policy committee will err on the side of caution when it comes to interest rate hikes this year.

The first move upwards is probably not going to happen until 2016. With the US also apparently sitting on its hands, there is no pressure on the Bank to keep up with Uncle Sam in order to protect the value of the pound.

What also seems clear now is that the trajectory of interest rates will be pretty flat going forward. That’s even more the case if the unexpected Conservative majority gives the Government the cover to push through tough spending cuts over the next couple of years. Monetary policy may have to do the heavy lifting again if fiscal policy is aggressive.

So savers and investors face an extended period of slim pickings. Anyone seeking a decent income will need to push into riskier assets, if they are not already there. Equity income funds can provide a high and sustainable yield with the prospect of growth as well.

Funds like Artemis Income, Fidelity Moneybuilder Dividend, Henderson UK Equity Income & Growth, JOHCM UK Equity Income and Liontrust Macro Equity Income – the five equity income funds on our Select List – will remain in favour in a world of persistently low yields.

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