UK economy poised to welcome deflation for first time since 1960

Britain could fall into deflation this week for the first time in more than half a century, the result of an escalating supermarket price war and falling energy prices.

Inflation, as measured by the consumer prices index, fell to zero in February for the first time since comparable records began in 1989. Estimates from the Office for National Statistics suggested that it was the lowest reading since 1960.

The statistics office will release the latest inflation figures, for March, on Tuesday morning. City economists say it is going to be a close call between a zero reading and a 0.1% dip.

Petrol prices rose 3.6% last month, reflecting a rebound in global oil prices, which is expected to push up the inflation rate by 0.1 percentage points. This will be offset, however, by the 5% cut in gas prices by British Gas, Britain’s largest energy supplier, and low food price inflation. Fierce competition from discount chains has forced the major supermarket groups to slash prices on basic items such as bread, with the discounter Aldi overtaking Waitrose to become the UK’s sixth-largest grocer recently.

Alan Clarke, an economist at Scotiabank, said: “While food price deflation of close to minus 4% year on year may sound extreme, this represents something of a relief after years of rapid price increases. More specifically, over the seven years between 2007 and 2013, the average annual pace of increase in food price inflation was 5% per year. Enjoy the cheap food and fuel while it lasts!”

UK inflation tumbled to zero in February, with many economists forecasting the fall to continue Photograph: Guardian/ONS
Even if the UK avoids deflation in March, it will probably enter a period of falling prices at some point soon – following in the footsteps of other countries. Eurozone inflation has been negative since December, and the US rate turned negative in January before recovering to zero in February.

There is no reason to panic, according to the Bank of England and City analysts. They claim any period of UK deflation is likely to prove temporary, unlike the deflationary spiral in Japan, where people have lived with falling prices for two decades.

The Bank of England governor, Mark Carney, has sought to allay fears that Britain faces a 1930s-style deflationary spiral, describing the falling oil price as “unambiguously good” for the economy. An oil glut pushed the price of Brent crude, the international benchmark, down by more than 50% from last summer to a six-year low earlier this year.

In the last major speech before the central bank goes into purdah ahead of the general election, policymaker Ben Broadbent also argued that deflation fears were overblown. “The likelihood of a broad and protracted deflation, afflicting wages as well as prices, is pretty low,” he said in late March.

Low, or non-existent, inflation means that there is no need to raise interest rates any time soon. The City expects the first rate rise, from the current record low of 0.5%, to come late next year. Further rate cuts seem unlikely, however. The Bank’s chief economist, Andy Haldane, recently surprised markets by suggesting rates could be cut again, but Carney and other members of the monetary policy committee disagree strongly, arguing that low inflation is likely to prove temporary.

Vicky Redwood, the chief UK economist at Capital Economics, argues that a dose of negative inflation would not be bad for the UK.

“We don’t think that deflation is a bad thing in its current form,” she said. “It has been driven by a drop in energy and food prices that is helpful for the economy. There is no evidence yet that a more damaging, long-lasting period of deflation is on its way.”

She noted that inflation expectations among households rose surprisingly in February. She, along with many other economists, expect inflation to be heading up again by the end of the year.

Inflationary pressures could also rise if sterling continues to weaken, which drives up import prices. The pound hit a five-year low against the dollar on Friday, ending the week at $1.4629.

Powered by article was written by Julia Kollewe, for on Sunday 12th April 2015 15.47 Europe/ © Guardian News and Media Limited 2010