Britain may have avoided its first fall into deflation in more than half a century, but it’s only a matter of time.
Official government figures for February published Tuesday showed inflation had slumped to zero, down from 0.3 per cent in January. The rate, as measured by the Consumer Price Index, had been widely expected to come in at 0.1 per cent.
This is the lowest figure since comparable records began in 1989. But according to unofficial CPI data compiled by the Office for National Statistics, the last time inflation was lower than this was in March 1960, when Harold Macmillan was British prime minister and John F Kennedy was running for US president.
The figure then was minus 0.6 per cent and the prospect of the return of deflation after over 50 years had economists and journalists thumbing through the history books, unearthing gems such as what was topping the singles charts back then (Lonnie Donegan's My Old Man's a Dustman).
Behind the sharp drop in the cost of living is the slump in the oil price, which has pushed down petrol and gas bills. The fierce supermarket price war has cut the cost of groceries and the data from the office showed price falls for tablets, laptops, toys and games.
Cost of living crisis
With the general election little more than 40 days away, and the “cost of living crisis” one of the key electoral battlegrounds, prime minister David Cameron leapt on the news, as did his chancellor, George Osborne. Cameron trotted out the well-worn mantra the government’s “long-term economic plan is working” while Osborne was a little more inventive: “Prices are frozen – as the recovery from Labour’s Great Recession strengthens, their economic argument has literally come to nought.”
The politicians appear unconcerned about deflation, and it is true “core inflation”, which strips out more volatile items including energy and food, is still at 1.2 per cent. But this is down from 1.4 per cent in January and, like the CPI figure, was weaker than expected.
The dangers of deflation are well-documented. If prices continue to fall, consumers become less willing to spend as they wait for goods to become cheaper still, which in turn will slow economic growth. Firms defer investment plans and debts, both consumer and corporate, become dearer to pay off in real terms.
The Bank of England’s chief economist, Andy Haldane, caused a stir last week when he suggested the next move in interest rates could be a cut rather than an anticipated rise.
In his view, the risks of deflation are greater than his boss, bank governor Mark Carney, believes. Even though UK interest rates have remained at a record low of 0.5 per cent for over six years, Haldane said a cut to zero was as likely as an increase.
Speaking to a business audience in the midlands, he said that “policy needs to stand ready to move off either foot in the period ahead.” Haldane’s warning put him at odds with Carney, who warned recently it would be “extremely foolish” to cut rates. Most economists agree, and the consensus is the next move in rates will be up, although maybe not until 2016.
The governor has already signalled deflation (or “negative inflation” as he prefers to call it) is an inevitable consequence of global forces such as the plunging oil price.
But according to Carney it will be only temporary and he is adamant that Britain will not suffer a 1930-style deflationary spiral. Instead, the governor believes, rising wages and the strengthening economic recovery will return inflation to the government’s target of 2 per cent within two years.
Boost for buying power
It’s easy to see why Cameron and Osborne welcomed yesterday’s “noflation” announcement. Wage growth, running at less than 2 per cent, remains weak but falling inflation has helped boost the buying power of households.
If deflation is a temporary phase, its impact should be. However, if falling prices should take hold, and if employers squeeze wages further, the feelgood factor of negative inflation will evaporate swiftly.
Fiona Walsh is business editor of theguardian.com
