24 Mar 2015

Inflation at zero per cent – and now for the bad news

Inflation is no more. The annual inflation rate is zero for the first time on record. So is the dawn of deflation a good or a bad thing?

Inflation‘s disappearance is thanks to falling gas and petrol prices, reflecting a spectacular fall in the cost of oil on international markets since last summer, writes Neil Macdonald. A price war between the “big four” supermarkets and the big discounters like Aldi and Lidl is pushing down food prices as well.

With more cuts in energy bills due to feed through, many economists believe inflation will turn negative next month and Britain is in for a bout of deflation.

For most of Britain’s post-war history, the country’s had a problem with too much inflation rather than too little. So is the dawn of deflation good news or bad? Here are three reasons either way.

  1. The most obvious good news first. Deflation means the cost of living is falling. The price of essentials is lower so your money goes further. This is particularly good news in Britain where inflation has been rising faster than wages for most of the last five years. That squeeze on living standards is over for now.
  2. Deflation should help companies too. Shops, factories and offices will be seeing their heating and lighting bills falling. Lower petrol prices will make it cheaper to move goods around the country.
  3. Deflation could bring lower interest rates too. The Bank of England is meant to keep inflation around the 2 per cent rate. It may decide that it needs to try and boost inflation by cutting rates or expanding its quantitative easing programme. Good news if you have a mortgate. Less good news if you are a saver – though as least deflation means your savings will go further.
Read more: Carney - inflation could fall below zero by spring

And now the problems:

  1. What if everyone thinks that prices are going to keep on falling in the future? Will people delay buying stuff because they think they can get it cheaper next month or next year? If everyone does that, it will hit economic growth.
  2. Will companies start worrying that the price they can get for their products will start to fall year after year as well. As their prices fall, will companies cut costs by trimming wages, laying off staff or slowing investment?
  3. And there could be bad news for anyone who owes a lot of money. Deflation may mean falling prices for petrol or food, but it doesn’t affect the cash value of your debts. And if companies start cutting wages and jobs, paying those debts will become more difficult.

Most of the problems with deflation only emerge if it goes on and on. So for the moment, we can enjoy it. If prices are still falling next year, it’s probably time to start worrying.