06 Feb 2024 2 min read

Thinking the unthinkable

By Willem Klijnstra

Should we be happy with inflation falling towards central bank targets, or does it just reignite deflation fears?


After a period of elevated inflation, markets are cheering the idea of falling inflation, as it will allow monetary policy to be eased. Financial assets typically like 'cheaper' money, and ideally more money in the system too.

The euphoria may have gone to extremes though, with markets pricing in many rate cuts, despite inflation remaining above target and few signs of economic slack.

When inflation falls, how do you make sure it stops falling? It's unlikely to stop magically if it hits the target. Won’t we soon start worrying about deflation again?

Was inflation a one-off?

Perhaps deflation is a too strong word here. We don’t actually need to see deflation for markets to get worried; just inflation that continues falling when it gets to target levels may be enough, as we need to consider the possibility that we’re just back to where we were before COVID-19.

Perhaps all the inflation we’ve seen since then was just a one-off based on the largest supply shock in a lifetime. 

Even today, a number of countries are in deflation, e.g., China and Thailand (see chart). China is one of the largest economies in the world, and the biggest exporter, so is exporting deflationary pressures to the rest of the world through the goods and commodity channels. Some sectors are more exposed to this than others, with the prime candidates being electric vehicles and solar panels.


Several producer price indices have moved into negative territory too, or in any case are below consumer price indices (see chart). This could be reflective of deflationary pressures in the pipeline, as producer prices should eventually feed into consumer prices. This is not just a China story. Of course, it is services inflation that is stickier at the moment rather than goods inflation, but during the inflation run-up services inflation was the one lagging as well. 

What’s driving deflation?

Looking at the countries with relatively low inflation today, we see Italy, Japan and South Korea. The three countries share low trend economic growth based on ageing populations.

The disinflationary force of poor demographics has resulted in these countries experiencing a lack of inflation, and even periods of deflation. Only last week we learned that South Korea’s birth rate has fallen to a new low. The rate for 2023 was just 0.72. This is a phenomenon that is spreading across most OECD countries, and as such will have a wider impact.    

We know inflation is very hard to predict, but when it’s falling rapidly towards target, worries about deflation could be just around the corner. In any case, it’s a risk scenario central banks and financial markets must deal with.

It may not be the dominant reason why we are long duration in our multi-asset portfolios, but we do believe it is supportive of the trade.

Willem Klijnstra

Currency Strategist

Willem is a stubborn Frisian, allegedly a descendant of an obscure hero resistance fighter called Grutte Pier (ca. 1480-1520). While in the office his focus is on currency movements; at home he does most of the moving as he chauffeurs his three young kids around. Mister currency is a sporty character with a balanced lifestyle – he enjoys burning lots of calories as much as he enjoys family sized bags of M&Ms.

Willem Klijnstra