What is the long-term outlook for UK inflation?

The policy of quantitative easing, that is creating money and injecting it into the system, was designed to increase the supply of money, while low interest rates should have helped with the velocity of money. 

But Stenning says the weaknesses of the global economy during that decade, when growth never rose above anaemic levels, and inflation generally remained very low, and for some periods, actually negative, where the direct result of the MV=PT equation were not working. 

He says while the central bank actions did increase the supply of money, this was not, on its own, enough to increase the velocity of money, and may in fact have reduced the velocity. 

I think the government actions have let the genie out of the bottle a little bit, and future recessions will also be met with higher government spending James Carrick, LGIM

If the velocity of money is slowing, that means fewer transactions are happening, which means economic activity is slowing, leading to lower growth, and lower inflation. 

Stenning says the effect of central bank actions was to cause house prices to rise, which meant younger people had to save more of their income to get a deposit; as younger people in normal circumstances spend more of their income, an increased savings rate among younger people sharply slows down the velocity of money. 

Low interest rates and gilt yields mean people nearing retirement may need to increase their pension contributions. This slows the velocity of money as it takes cash earned now, but delays the spending of it for years.

The final issue is if low bond yields are contributing to company pension funds being in deficit, companies are then required to inject cash into the fund, leaving less cash for that company to spend today, on expansion, or pay rises. 

 Fiscal flows

James Carrick, global economist at Legal and General Investment Management had been expecting a generally deflationary environment for the UK for years, but says the policy response to the pandemic from governments has changed the equation.

Governments have responded by increasing their own spending, alongside the central bank actions.

Governments spending directly into the economy should direct cash to lower earners, who are more likely to spend it, increasing the number of transactions, and so also the velocity of the money supply alongside the quantity rising, leading to higher growth and inflation. 

He says: “I think the government actions have let the genie out of the bottle a little bit, and future recessions will also be met with higher government spending, and that changes the long-term growth and inflation outlook.”