With UK economic activity stalled, demand for goods and services goods and services are falling. As a result, prices are dropping too, or at least not rising as fast as they would otherwise have done, as the latest consumer price inflation data, which now includes housing costs, shows.
The CPIH data showed that inflation is now running at just 0.9%, down from 1.5% in March, and significantly lower than the Bank of England’s 2% target.
And if demand continues to be slack, as rising unemployment bites deeper into the nation’s ability to spend, it could go even higher.
The Head of Investment at Close Brothers Asset Management was quoted this week as saying that inflation may edge “close to zero” over the coming months.
Investors on the bond markets, and the government too, are well aware of this trend.
The UK government sold gilts with a negative yield for the first time in its history on 19 May, meaning investors paid for the privilege of borrowing from the UK government.
The three-year bond, which matures in 2023, raised £3.75bn, and offers a yield of -0.003%.
Perhaps not surprisingly, demand for the bond was low by recent standards, with investors bidding for just over twice the £3.75bn on offer.
The last time a bid-to-cover ratio was below 2.15 was on March 19, before the Bank of England announced it would buy an extra £200bn of assets to support the economy through the coronavirus crisis.
What this means for the future of interest rates, as set by the Bank of England remains to be seen. But the latest issuance certainly throws open the possibility that the Bank of England will follow the lead of the European Central Bank and take official rates negative.
It’s likely that the offerings of gilts with negative yields may be part of a concerted effort to keep the government’s borrowing costs down.
This will be rendered easier than it might otherwise have been because one of the main buyers of the gilts issued by the government’s Debt Management Office is the Bank of England itself, which is creating new money to pay for it via its quantitative easing programme.
But when combined with lower inflation numbers, this drive to lower borrowing costs may end up spurring prices even lower, since if real returns can’t even be generated by holding debt, since the market is apparently to pay more for now for an asset that will be worth less in the future.
On the other hand, some key constituents of the CPIH, most notably oil, are now beginning to recover their value, so there will also be some upward pressure too.