deflating news

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    Financial Times

    Fears grow that US economy faces deflation
    By Jenny Wiggins in New York, Peronet Despeignes in Washington and David Pilling in Tokyo

    Published: May 16 2003 21:37

    Fears of deflation in the US rose on Friday as stock prices fell and government bond yields dipped to 45-year lows after a key measure of inflation dropped to its lowest level in 37 years.

    The concerns were heightened by reports that Japan’s deflation gathered pace in the first quarter with prices down 3.5 per cent from a year ago, their fastest 12-month drop on record.

    The fall may fuel concerns that the Japanese economy could be in a deflationary spiral. Japanese prices have been falling since 1995 at an average annual rate of 1 to 2 per cent. The latest figures showed deflation accelerating in the 2002 financial year to 2.2 per cent, a record for a full year.

    In the US the yield on 10-year and 30-year US Treasury bonds fell to 3.49 per cent and 4.45 per cent in early trading.

    Longer-dated US government bonds have rallied sharply this week, with investors convinced that inflation will remain subdued, having less of an impact on the value of long-term assets.

    The Labour Department reported that the 12-month rise in its core consumer price index fell to 1.5 per cent in April, its slowest 12-month rate of increase since January 1966. Strategists said the subsequent fall in bond yields could, however, be positive for the economy. "This is what the Federal Reserve wants," said Dominic Konstam, head of interest rates products research at Credit Suisse First Boston.

    Falling yields mean falling borrowing costs, which make it easier for businesses to borrow and homeowners to refinance mortgages and get extra cash - factors that have helped keep the economy afloat. But the sharp slowdown in inflation has inflamed talk of Japanese-style deflation.

    Japan’s deflation figures were released along with gross domestic product figures showing that growth in the first quarter fell to almost zero, leading some economists to conclude that the economy was on the brink of yet another recession. Nominal growth fell 0.6 per cent in the March quarter, or minus 2.5 per cent on an annualised basis.

    Paul Sheard, economist at Lehman Brothers, said: "If you look at the chart it looks horrible. It looks as though deflation is going through the floor." However, the headline figure exaggerated the picture, because the GDP deflator in the first quarter of 2002, when Japan began pulling out of recession, was positive, he noted. "It’s something of a statistical fluke, though deflation is deflation and it is not a good sign." Most economists in the US have dismissed deflationary risks as marginal. But the Fed said recently that odds of an "unwelcome substantial" slowdown in inflation were now stronger than that of a rebound. "We continue to believe that inflationary pressures are building," said Brian Wesbury, an economist with Chicago-based, bond-trading firm Griffith Kubik, Stepehens and Thomson, but "it is getting harder and harder to argue against the deflation story".

    Concerns have also grown about a global-wide deflation which the US could import, as western Europe flirts with recession and Japan looks more likely to enter a deflationary spiral.
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