Concern rises over deflation

Cost of living boost as inflation slumps to 0% for first time

shoppingInflation fell to zero last month for the first time ever, providing a boost to the coalition ahead of the General Election but prompting concerns among economists that it could turn negative.

It may prompt the Bank of England to cut interest rates further, although this morning’s news led to a fall in sterling.

The lower cost of living will help create a feelgood factor as wages are now rising faster than prices in the shops.

It could also fall below 0% as cuts in utility bills are likely to push down on prices this month.

But deflation is a worry as consumers stop spending in anticipation of prices falling further.

The figures from the Office for National Statistics show consumer price inflation dropped to 0% in February from an annual rate of 0.3% in January. The ONS believes inflation might have been lower in 1960 based on unofficial estimates.

The fall is bigger than the 0.1% predicted by economists. It is now below the Bank of England’s 2% target.

BoE Governor Mark Carney told legislators earlier this month that cutting rates purely in response to falling oil prices would be “extremely foolish”, and most economists polled by Reuters expect the next BoE move to be a rate rise in around a year’s time.

Unlike in the euro zone, where prices are already showing year-on-year falls, most economists think British consumer demand will remain firm in the face of falling prices, due to robust employment growth and signs of a pick-up in wages.

Todays data showed downward pressure on inflation from falling prices for food, laptops, tablets and computer accessories.

Rain Newton-Smith, CBI Director of Economics, said: “Despite inflation dropping to zero, it is unlikely we will see falling prices for a prolonged period, particularly as the pressure from lower oil prices fades.

“While lower oil prices are cutting costs for businesses, and leaving households with more money in their pockets, North Sea oil producers are taking a hit. The measures to support the industry in the Budget will help address concerns over job losses and investment freezes, but it is not out of the woods yet.

“With the Monetary Policy Committee still alert to the risk of very low inflation becoming entrenched, a rise in interest rates anytime soon seems off the cards.”

James Sproule, chief economist of the Institute of Directors, said: “We welcome the news that inflation has once again fallen. It is particularly encouraging that this has been driven by falling fuel costs. This is putting extra spending power directly into people’s pockets and is acting as a further catalyst to economic growth.

“Looking to the longer-term, we are encouraged that IoD members are planning pay rises for their staff in 2015. In the majority of cases these will be tied to improved corporate performance. This is the sort of responsible decision which will ensure economic growth is sustainable.

“However, low inflation does mean that governments must be that much more careful with decisions on tax and spending, as very low, or zero, inflation means miscalculations cannot be eroded in future years by inflation. An incoming government must be very aware that they will have to live with any changes to tax rates or thresholds for the long term.”

John Hawksworth, PwC’s chief economist, said: “Consumer price inflation fell to a record low of zero in February and we expect it to move into slightly negative territory over the next month or two. But we think this represents a good form of deflation in which lower global food and energy prices provide a much needed boost to household real income levels, helping to end the real wage squeeze of the past six years.

“It is true that core inflation, excluding energy, food, drink and tobacco, also eased to 1.2% in February, back to the levels seen in November. The MPC is therefore under no immediate pressure to raise interest rates, but they will also be aware that the medium term impact of lower global commodity prices will be to boost the UK economy, potentially pushing up wages and prices.

“We would therefore still expect the first interest rate rise to come by early 2016, with inflation moving back towards target by the end of that year.”

David Lamb, head of dealing at the foreign exchange specialists FEXCO, said: “Consumers may be revelling in cheaper prices, but for economists this is a code red moment. While there is no surprise at the fall in inflation, both the speed and the scale of the drop are alarming. We are in an oasis on the edge of an abyss.

“Mark Carney has breezily predicted that though inflation would turn negative in spring, Britain would escape a deflationary spiral. But with inflation in freefall, that assessment is now looking dangerously optimistic.

“It now seems certain that Britain will fall into deflation in March. This is unknown territory, and we should expect policymakers to take drastic action to prevent deflation taking root.

“The Bank of England’s chief economist has already raised the prospect of interest rates being cut to the bone to stave off the pernicious effects of long-term falling prices.

“After six straight years at their current historic low, the prospect of interest rates being cut even further is weighing heavily on sterling – and the pound has slid against the dollar and euro.”

Andy Scott, associate director of FX advisory services at foreign currency firm, HiFX, said: “The pound came under renewed pressure against the euro. Having hit 1.4250 two weeks previous, its highest level in over seven years, the pound has since dropped back by 4.5% to 1.3600 today.

“The Bank of England warning on inflation turning negative this year and the chief economist highlighting the BOE could still ease policy in order to return inflation to its 2% target has weighed on the pound. A pickup in euro zone data has also seen the euro regaining some ground.

“This clearly isn’t an environment that warrants a rate hike and unless wage growth picks up sharply from its currently rate of 1.8%, the few hawks on the MPC are going to have a very difficult job in convincing the majority that a rate hike is necessary this year. Regardless of there being only a very slim chance of a U.K. rate hike this year, we expect sterling to remain strong against the euro and to recover against the dollar in the months ahead.”

Calum Bennie, savings expert at Scottish Friendly, said: “Barring a sizeable shock, the writing is on the wall that the economy will be in deflation within a couple of months. If this is the case, the Bank of England may find themselves under increasing pressure to cut interest rates from their all-time low of 0.5%. This is great news for borrowers, but places further pressure on cash savers across the country.

“The outlook for savers is not good and those looking to build up deposits will have to scurry around to get decent rates on cash accounts. Alternatively, for a long term investment, now could be the time for people to consider stocks and shares, or investment ISAs.

“This prolonged period of low inflation means that living standards will be at their highest for a decade. The temptation may be for families to rein back on austerity but equally the time is right to put any surplus cash aside for all the things in life that people will need in the future.”

Chris Williams, chief executive, Wealth Horizon said: “The UK is now experiencing ‘noflation’. The real question for investors is how long this scenario lasts. Certainly, this is not a normal environment, and investors need to be aware that inflation will not stay this low forever.”

Steve Lewis, head of retirement distribution at LV=, said: “The current economic environment creates a real challenge for someone retiring today. The Governor of the Bank of England has clearly stated that the outlook for inflation in 2015 may well be negative and yet in the next few years inflation will return to target and then rise a little further.  The impact on interest rates in the short term has been negative and the knock-on effect to annuity rates has been inevitable. Some may therefore take the view that higher rates in three to five years’ time may provide more attractive conditions for locking into long term guaranteed returns.

“The retiree has to recognise that inflation is perhaps the biggest risk to their retirement income plans.  Setting out for a lifetime in retirement based on an expectation that today’s environment will continue would just be wrong.  Individuals and advisers need to understand and plan for inflation.”

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