From inflation to deflation: causes, effects and market outlook - a financial expert analyzes the current developments.

From inflation to deflation: causes, effects and market outlook - a financial expert analyzes the current developments.

According to a report by finanzmarktwelt.de, deflation describes the decline in price levels in an economy, while inflation is characterized by rising prices. The causes of deflation can be a reduction in the money supply and less investment by companies, triggered by restrictive monetary policies of central banks.

After a sharp increase in the money supply during the pandemic, this triggered inflation, which was curbed by the Fed and ECB with an aggressive cycle of interest rate hikes in 2023. The annual inflation rate in the US fell to 3.1% in November 2023, while it slowed to 2.4% in the euro zone.

It is now being discussed whether the steep price rise could be followed by deflation. Historical data shows that strong bouts of inflation are often followed by rapid declines and ultimately deflation. Although the inflation rate in the USA is currently still 3%, there are arguments pointing to possible deflation.

According to economists, deflation would be even more dangerous than inflation because consumers and companies would hold back on purchases in anticipation of falling prices. There are therefore concerns that markets are being too optimistic about the slowdown in inflation and are expecting massive interest rate cuts from central banks to enable a soft landing for the economy.

A possible deflation could have a strong impact on the stock markets and threaten expectations of a jump in corporate profits in 2024 and the avoidance of a recession. Markets are therefore walking a fine line as the best-case scenario depends on avoiding renewed inflation and a soft landing for the economy. It remains to be seen whether current indicators actually point to possible deflation.