The new normal

Ever since Paul Volcker took charge of the US Federal Reserve in 1979 and successfully eradicated high inflation, it has been one-way traffic. Global inflation has been on a downward trend, as G-10 countries now grapple with rates of inflation that are far below their target rates. This long-term trend in inflation has been a key driver behind the strong performance of government bond prices over the past 30 years.

More recently, inflation has tumbled to multi-decade lows in line with the price of oil. Energy makes up around 10 per cent of the personal consumption bucket in developed markets, while significant price falls have detracted from the headline rate of inflation.

How depressed the price of oil remains is hard to forecast, however we would be hard pressed to assume that the price of a barrel falls another 50
per cent in 2016.

Inflation is typically reported as a year-on-year calculation, i.e. a comparison of the current underlying rate of inflation given where it was this time last year. From this we can extrapolate that, as the price of energy stabilises, the reported figure for inflation should gradually move upwards.

Perhaps not aggressively at first, but enough for the world's central bankers to think that we are not heading towards a permanently disinflationary world. A gradual move up would also impact government bond markets, as prices would fall to compensate investors for higher inflation.

Technology's unstoppable force

There are opponents to the view that inflation will trend significantly higher, citing the longer-term impact of technological advances on the global economy. The exponential growth of companies such as Google has had important consequences for consumer behaviour.

No longer do we trawl the length
of the high street to find the lowest price for our goods. Now we are just one click away from finding the cheapest price, with results displayed
in less than a second.

This transparency of pricing has forced department stores and high street shops to act competitively on price of goods. This, of course, is of huge benefit to the consumer, but has long-term structural implications for the pricing
of consumer goods and in turn the retail industry.

It's not just technological advances through the internet that are bringing prices down, but technological advances through production techniques are contributing too.

The shale gas revolution is one example of this - the process of hydraulic fracturing has been developed over the years and is now at a stage where it is a commercially viable production technique.

Where drilling once took place in remote locations in order to access natural resource, technology now allows for more efficient extraction, which brings cost savings. An example of this is Shell's recent decision to close its Arctic drilling site.

The new normal

So where does this leave the future
path of global inflation? We could expect inflation to be materially lower in the future, but the more pressing question to be addressed is, how does this change the functioning of financial markets?

It is clear that central banks may need to re-examine the validity of their mandates. In the US, the Federal Reserve observes a dual mandate, whereby it is committed to achieving both maximum employment and stable prices.

In the case of the Bank of England and the European Central Bank, both observe the single mandate of maintaining price stability.

It is clear that maintaining mild inflation is a key priority, but in a world where structural changes are impeding the path for inflation, central banks may have to reconsider their raison d'être.

If they were to go ahead and adjust their mandates to reflect the new world we live in, then maybe we might be able to officially call it 'the new normal'.  

Jordan Sriharan is a senior investment analyst at Thomas Miller Investment