China set to trigger deflationary meltdown – and still the BoE hikes interest rates | Personal Finance | Finance

As ever, the BoE is behind the curve. In 2021, just as it became clear that inflation was about to take off, its dozy governor Andrew Bailey dismissed the threat as “transitory”.

The Bank’s rate-setting monetary policy committee (MPC) was slow to react as a result, worsening the cost-of-living crisis.

It has since increased base rates for 14 meetings in a row to today’s 5.25 percent, and is expected to hike them again in both September and November.

I’ve repeatedly called on the MPC to pause the rate hikes as monetary policy takes around 18 months to work but the BoE is expected to plough on despite growing signs that the world is slipping into deflation.

This error could prove just as painful as the last one.

Deflation occurs when the price of goods and services shrinks rather than rises. That will sound attractive after all we’ve been through but the relief will be shortlived.

When deflation strikes, consumers stop spending. Why buy something today when you can get it cheaper tomorrow?

As a result, companies make less stuff because they will earn less money. They cut salaries and sack staff to balance the books, which lowers demand and prices, triggering a miserable downward spiral.

And China is already there.

Latest figures show Chinese consumer prices falling 0.3 percent in the year to July. Factory prices fell 4.4 percent.

Even food prices are falling.

The impact will not be restricted to China.

If Chinese companies can’t get a decent price for their goods and services at home, they will look to dump them in key European and US export markets.

Which will drive down prices over here.

It’s already happening. Tesla is responding to competition from Chinese electric vehicle manufacturers by slashing the prices on some models by $10,000.

Cheaper food? Cheaper cars? Cheaper everything stamped “Made in China”? 

What’s not to like?

First, it’s not going to be an orderly retreat. The potential collapse of China’s largest real estate developer Country Garden has left the world economy on the brink.

Unless Beijing steps in, contagion may destroy the Chinese shadow banking system. It’s worth $3trillion, which is roughly the size of the UK economy.

The US may follow China into deflation, Mike Wilson, chief investment officer at Morgan Stanley, has warned. The world’s biggest economy has a 50-50 chance of shrinking in size.

Steen Jakobsen, chief investment officer at Saxo Bank, spent most of this year thinking the US would avoid recession. Now he says it’s hurtling into stagflation thanks to “punitive” interest rates, a slowing jobs market and “sticky” energy prices.

READ MORE: Warning of ‘trouble ahead’ despite UK economy growing 0.5 percent in June

Jakobsen reckons both US Federal Reserve and European Central Bank will be forced to cut interest rates this year to avert meltdown.

That seems unthinkable today but the process has already begun. “Emerging markets led the world in restrictive monetary policy, but now they are starting to cut rates,” he says.

Our banks seem to have got the message, with a heap of banks now cutting mortgage rates.

At the same time, savings rates appear to have peaked.

But will the message get through to the BoE? It still seems hellbent on hiking rates while ignoring signs that the UK money supply has collapsed. It is likely to double down after today’s high wage growth figures.

Simon Ward, economic adviser at Janus Henderson, says inflation follows the money supply and is set to shrink fast.

Headline consumer price inflation could be down to four percent by year end, below Prime Minister Rishi Sunak’s five percent target, he says.

Albert Edwards, co-head of global strategy at Société Générale, says the current “shocking decline in the money supply” is being ignored by central bankers, and this could yet result in “financial collapse”.

Edwards is known as Dr Doom for his gloomy forecasts, but even so.

Despite the looming danger the BoE looks set to carry on fighting yesterday’s problems rather than tomorrow’s.

We’ll all pay a high price if it doesn’t wake up and halt the rate hikes now.