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A year from now, will we be talking about galloping inflation or a plunge into deflation? I think the odds favor deflation, or at least lower inflation. Housing is in free-fall, and with the European economy weakening, we are looking at the prospect of sharply slowing global growth. The economists at Deutsche Bank regard this as one real possibility:
All major asset markets except those for commodities are presently weakening. This, and the fall-out from the financial crisis, could exert stronger downward pressure on global growth than anticipated in our baseline scenario. Should commodity markets then follow the other asset markets—which would seem plausible when global growth weakens by more than presently expected—inflation could drop faster and by more than anticipated in our baseline forecast. Far-fetched as it may sound at present, fears of deflation could return and interest rates could drop again towards the lows reached earlier this decade
The real question is whether the growth slowdown spreads from the developed countries to the developing world. I can’t see how it doesn’t
(For more on deflation, see Roger Bootle writing in the Telegraph with a story headlined “Deflation rather than inflation could soon be our big worry”)