Low Inflation: A Curse or a Blessing?

Posted: 6th February 2015

Studying Economics at the University of Warwick, I was taught that a moderate level of inflation is beneficial for the economy. Ronald Reagan once said “inflation is as violent as a mugger, as frightening as an armed robber and as deadly as a hit man.” To contain this robber and make high inflation a thing of the past, several measures such as actively pursuing an inflation target and giving more independence to the Bank of England, have been put in place.

So much was my interest in this topic, which affects all corners of society, that I completed my dissertation on exploring the effects of differing levels of central bank independence on the prevailing inflation rate. Since joining Altair as an intern, my interest has now extended into analysing the effects of inflation on social housing policy. In particular I wanted to explore if this current low inflation blessing is in fact a curse for social housing providers.

Global events affect the inflation rate and undoubtedly, falling oil prices are contributing to this. As inflation continues to fall, social landlords will be nervously watching the direction its heading. Next September’s Consumer Price Index (CPI) value is of great importance as it forms the basis on which social landlords can increase their rent, a major source of their turnover, for the following year. Furthermore, social landlords that have tight loan covenants in the medium term could see the gap between their income and expenditure erode away pretty rapidly. This reduction in operating surplus could have a knock on effect on reserves and the ability to finance future development activity. For some, it will be about survival.

Not surprisingly, the need for robust stress testing of business plans is crucial. Following Mark Carney’s lead, the HCA issued warnings of interest rate spikes and variations in house prices in late 2013, but now it looks like lowering inflation rates, and possible deflation, are likely to be at the top of the agenda.

With inflation lowered, there is less pressure for the Monetary Policy Committee to raise the interest rate, removing concerns of the effects of an interest rate hike for the moment. Conversely, a higher level of inflation may be better for the social housing sector as it provides a greater comfort gap between income and expenditure.
However, on the flip side, low inflation could benefit those social landlords developing new properties, as prices of raw materials decline. Lower inflation can act as a brake on development costs, spurring more activity.

And to add to the complexity, the growing popularity in CPIH, which includes owner occupied housing in its calculation, replacing CPI as the national measure of inflation poses another threat to social landlords. This new measure, recently endorsed by the Director of the Institute for Fiscal Studies, has either been the same or slightly lower than CPI in the past. If rent setting is to be linked to this value, social landlords will need to look long and hard at their cost base structure to ensure they can cope with lower rent rises.

Overall, it looks like low inflation, at least in the short term, might not all be bad for social landlords. Instead they should consider what blessings to count and what curses to avoid when it comes to inflation.

Mihir Shah is an Intern with Altair. For further information, you can contact him on 020 7934 0175 or email: mihir.shah@altairltd.co.uk.

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