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Inflation falls to zero in February – what does this mean for the British economy?

Inflation fell to zero for the first time on record in February, as falling oil prices, a supermarket price war and cheaper books, toys and games pushed Britain closer to deflation.

According to The Financial Times, inflation dropped from 0.3 per cent in January, against economists’ expectations of a fall to 0.1 per cent. The news hit sterling, which was down 0.4 per cent against the euro [1].

The ONS said February’s decline was driven by falling food prices, which subtracted 0.4 percentage points off the headline rates, whilst prices of “recreational goods and services” and cheaper petrol also pushed inflation lower, said the Telegraph.

George Osborne welcomed the news, tweeting that the data represented a boon for British consumers:

“Inflation at zero is a first for the British economy. Low inflation due to falling oil prices is good news for family budgets”.

There is a general assumption that low inflation is a boost for everyone; however some do better out of zero inflation than others. According to The Guardian, pensioners benefit because “the triple lock means that the state pension is up rated by whichever is highest of the annual inflation rate, average earnings or 2.5 per cent. At present it is 2.5 per cent.” Deflation also benefits those with cash in the bank, since their money will get them more in the future than it does now.

Samuel Tombs at Capital Economics gave British consumers further validation to celebrate zero inflation, as he calculated that the fall in oil prices over the past 6 months has increased the amount households have to spend on goods other than petrol by £10 billion.

According to the Financial Times, the Bank of England revised last week its forecast for the growth in real post-tax household income for this year, raising it from 1.25 to 3.5 per cent.
Whilst economists believe that the drop is a boon for consumers, the news is not universally welcomed by all. According to the BBC economics editor Robert Preston, the prolonged stagnation of prices could turn into fully fledged deflation. The point being that if it was assumed that the price of household goods, such as a washing machine or motor car, were continuing to drop, the more likely it is that consumers will defer purchases of such things, which would further depress the economy. This would lead to the same experience as Japanese-style bad deflation, which could undermine prosperity for years.

The collapse in oil prices also has a “chilling effect” on North Sea Oil, having already caused BP to cut nearly a tenth of its workforce in the Scottish Fields.

However, analysts at Investec believe that inflation could pick up quite quickly at the end of this year. “We judge that the UK is at or close to the trough of the inflation cycle and our profile envisages a steady climb to 1.4pc by end-year, helped by the sharp falls in energy prices in the second half of 2014 dropping out of the annual calculation. Such an inflation profile would encourage [Bank policymakers] to begin to raise the Bank rate gradually by the end of this year,” said Philip Shaw, an economist at Investec.

Maike Currie and Fidelity Worldwide Investment also commented that there is no evidence to suggest that consumers have deferred spending in the belief that cheaper prices lie ahead, stating:
“No one is going to delay their weekly trip to the supermarket or stop filling up their car’s petrol tank, because they expect prices may fall next month.”

All nine members of the Bank’s monetary policy committee are in favour of official interest rates remaining at 0.5%, which is where they have been since early 2009. They look like remaining there for the rest of this year, and one MPC member- Andy Haldane, the Bank’s chief economist- says he can contemplate voting to cut borrowing costs [2]>. “Mr Haldane also expressed his personal concern that the relationship between growing employment and wage rises has weakened – such that the strength of the UK’s economic recovery and the fall in unemployment might not be leading to sufficiently rapid wage growth that would force inflation back to target [3].”

Therefore the real test to determine whether this is good or worrying deflation will rely on what employers decide to pay their workers over the coming year.

Sources:

http://www.telegraph.co.uk/finance/economics/

http://www.ftadviser.com/?ftar=true

http://www.theguardian.com/uk/business

http://www.bbc.co.uk/news/uk


[1] Ferdinando Guigliano, The Financial Times
[2] Larry Elliott, Economics Editor, The Guardian
[3] Robert Preston, Economics Editor, BBC