By Brian Tora
Dividing my time between England and the Algarve provides an opportunity to compare the way of life between the two countries. In Portugal, the rules surrounding how to behave in the face of the pandemic have been stricter than back in England, which is somehow rather comforting and it does feel more relaxed here. True, warmer weather makes staying outside for much of the time easier than is the case in England.
One similarity is that the building industry appears to be booming in both places, with house prices soaring. Indeed, it appears that property values all around the world are on the up. Quite why an outbreak of a highly contagious virus, which has disrupted life in so many different ways, should spark a boom in house prices is difficult to understand. Perhaps it is the fear that inflation could be rekindled, bringing to an end a lengthy period of relatively stable prices. Certainly, the cost of living is being driven up in many corners of the globe.
The pandemic may indeed be responsible in some measure. Real estate agents in both the Algarve and England have reported a dearth of properties for sale. It seems many of us are less inclined to move, perhaps because successive lockdowns have encouraged us to stay at home. Yet demand for houses continues to rise from those who have been prompted to seek out a change in lifestyle, perhaps again because of COVID restrictions. Add this to the upward pressure on the cost of living brought about by escalating energy prices and higher inflation looks inevitable.
High and sustained inflation is definitely something to be feared and avoided at all costs. Modest inflation, on the other hand, is viewed as a beneficial influence and is even encouraged by governments. The target for inflation in the UK – and in the US for that matter – is +2% per annum, with a tolerance of 1% built-in on either side. In other words, providing the rise in the cost of living stays in the range of 1% to 3%, the Prime Minister and the Chancellor of the Exchequer can feel relaxed – well, relatively. With inflation running at 3.2% for August and expected to rise to 4.5% by the year-end, perhaps Downing Street is a little less relaxed now.
Inflation in Portugal seems to be less of an issue, despite rising house prices. Last year the cost of living was barely changed, with the headline inflation rate coming in at -0.01%. Half way through the current year inflation had risen to +0.5% on an annualised basis. I do not know if the government here sets a country inflation target, but the European Central Bank, which claims not to set targets – understandable, given the number of countries in the eurozone – considers 2% an acceptable ceiling rate.
It is not too difficult to understand why governments consider modest inflation as a good – arguably a necessary – aspect of economic management. Knowing that goods might cost that little bit more next year encourages people to spend and the actions of the consumer are crucial in ensuring our economy maintains an upward path. The other side of the coin – deflation, where prices actually fall – stifles consumer demand and can send the economy into a downward spiral.
While comparatively rare, there have been recent examples of how deflation can damage growth. Japan, which enjoyed explosive post-war economic expansion as it rebuilt its economy and geared up its manufacturing capabilities, stalled towards the end of the 1980s and entered into a period of prolonged low or negative inflation which cut growth and led to a massive implosion in the value of its stock market.
Of course, inflation can bring benefits. It enhances the value of some assets and devalues debt. Those of us of the baby boomer generation able to buy their own homes in England will have benefitted hugely from the uplift in house prices generated by successive years of relatively high inflation and the lessening of the value of their mortgages compared with the price their homes were able to command. As it happens, the rise in house prices has actually outstripped inflation, but the rise in the cost of living definitely helped.
In the 1970s, UK inflation rose to dangerously high levels, peaking at 25% or thereabouts. Interest rates rocketed and in the end, the country had to be bailed out by the International Monetary Fund. I’m not expecting this scenario to be re-enacted, but we need to keep an eye on what is happening to prices and wages. Perhaps the threat in Portugal is not as great, but many of us will be concerned about what is happening back in the UK. There, a perfect storm of supply disruption and labour shortages, brought about by a combination of Brexit and the pandemic, could yet see inflation and interest rates return to levels not seen in decades. I hope not, but you can’t be too sure.
Brian Tora is a financial journalist and broadcaster
