What's going on?
On Friday, data showed that recent inflation rates in America and Europe were both lower than economists had expected – and it might signal that the economies on both sides of the Atlantic aren’t quite as strong as many think…
What does this mean?
Recent evidence suggests that economic growth in both America and Europe is accelerating. But if major economies like the US and Europe are indeed growing relatively strongly, then prices in those economies should also be rising relatively quickly (as demand for goods and services increase). But, instead, inflation is staying stubbornly low (especially in the US) – suggesting there is something amiss.
Why should I care?
The bigger picture: Low inflation may seem like a good thing, but it’s not really.
Nobody wants to pay more for stuff, right? So isn’t low inflation a good thing?! Not quite. One of the biggest problems with low inflation is that most major economies have a huge amount of debt. One of the easiest ways to help us repay that debt is to have higher inflation: the more we make in the future, the easier it becomes to pay down the debt we have today. Without much inflation though, relatively more money is spent paying off debt rather than on inventing new things and improving productiveness (which tend to benefit society as a whole).
For markets: It’s tough for interest rates to go up much unless inflation leads the way.
Usually, when inflation is low, investors are willing to lend money at relatively low interest rates (because when they get paid back, the value of the money hasn’t eroded very much – and so they don’t need as much in interest to compensate). But over the past few weeks, interest rates (as represented by bond yields) have increased rather sharply. It is likely that investors are betting that inflation will soon increase – but if it doesn’t, interest rates are susceptible to falling back down (or, in other words, bonds could likely go back up in price).