Inflation falls to record low: What it means for interest rates, sterling and more

17th February 2015

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UK inflation fell to 0.3% in January – the lowest level since the Office for National Statistics began to publish the Consumer Prices Index in 1997.

CPI grew by 0.3% in the year to January 2015, down from 0.5% in December 2014. It means that a basket of goods and services that cost £100.00 in January 2014 would have cost £100.30 in January 2015.

In the year to January 2015, prices of motor fuels fell by 16.2% and food prices fell by 2.8%., which were the main contributors to the falling inflation rate.

The previous lowest CPI 12-month rate was 0.5% in May 2000 and December 2014.

What does it mean for interest rates?

Ben Brettell, senior economist at Hargreaves Lansdown, said: “The Bank of England expects the rate of inflation to drop below zero for at least a couple of months this spring, and remain close to zero for the rest of the year.

“If it turns negative this will be the first ‘deflation’ experienced in the UK since the 1960. [Bank of England governor] Mark Carney was at pains to point out last week that risks of a deflationary slump were minimal, but MPC member Martin Weale (who until December had voted for higher rates) explained that the risk of low inflation expectations causing a deflationary spiral was what persuaded him to abandon his calls for a rate rise.

“This suggests opinion at the Bank is somewhat divided.”

The Bank estimates two thirds of the weakness in inflation can be explained by external factors such as unusually low energy and food prices. The remaining third is down to subdued inflationary pressures domestically. In other words – two thirds ‘good’ deflation and one third ‘bad’ deflation, Brettell explained.

“The combination of low inflation, rising wages and falling fuel prices are great news for the UK consumer. Last week the Bank of England forecast real after-tax incomes would rise 3.5% this year, the strongest growth for 10 years. This in turn should be positive for economic growth, and this is reflected in upgraded forecasts from the Bank of England, Confederation of British Industry and the NIESR. These suggest the UK economy will grow between 2.7 and 2.9% this year,” said Brettell.

Current forecasts suggest interest rates might start rising later this year or early in 2016. But Brettell believes they will stay lower for longer than the majority of forecasters expect. “I don’t see them rising until mid-2016 at the earliest,” he said.

What does it mean for savers?

Sylvia Waycot, Editor at Moneyfacts.co.uk, said: “It’s official, after tax and inflation, the average interest paid on easy access savings accounts, which is currently 0.66%, isn’t even enough to buy you one sausage a week*.

“Any saver who deposited £10,000 in an average account five years ago will find that while they still physically have £10,000, it is worth much less today. Over 60 months the loss equates to around £20 per month, leaving you with £1,200 less bang for your buck!

“There are a total of 558 savings accounts (218 fixed bonds, 55 notice, 98 no notice and 187 ISAs) to choose from that pay enough interest to negate the effects of tax and inflation*.

“The average interest paid across the ISA range is still miserable at 1.44%, even less than last year when it was 1.65%.

“Inflation has hit a new low, and although this helps today’s savings interest go further, it still won’t get you a sausage.”

What does it mean for investors?

Maike Currie, associate investment director at Fidelity, said: “Investors need to distinguish between disinflation – a slowdown in the rate of inflation and deflation – a persistent and ongoing fall in prices – the two are not the same thing.

“It is worth remembering that both food and fuel – the main drivers of the fall in inflation – are two essential items. 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.

“Deflation is dangerous because it causes companies and consumers to do the exact thing that causes more deflation – delay spending in the hope of further price falls in future. In light of this, tomorrow’s wage growth figures will be an important indicator as to how  expectations about the future path of inflation are panning out. ”

Investors who believe the current rate of inflation in the UK is uncomfortably close to deflation, and want to shield their portfolios against this threat, should look for companies with strong brands which benefit from pricing power, according to Currie. Companies that have a unique product and strong brand will be in a better position to increase prices regardless of the broader economy, she said.

Currie added: “A number of the UK fund managers adopt an investment process which focuses on industry leading, quality companies that have been around for generations and are likely to be around for a long time to come. Examples include Nick Train of the CF Lindsell Train UK Equity Fund and David Dudding of the Threadneedle European Select Fund.”

What does it mean for sterling?

 Andy Scott, associate director of FX advisory services at foreign currency specialists, HiFX, said:  “This morning’s news that UK consumer price inflation is at a record low is very good news since we have an economy that is on the right path with robust growth and falling unemployment. Sterling weakened by around 0.5 cent against both the dollar and the euro following the release, since the disinflationary environment would suggest a neutral or easing monetary policy stance. The Bank of England however recently suggested that the next move will be to hike rates, albeit not for a while yet.

“The components where prices are falling are predominantly food and energy, neither of which people can hold off buying for any real length of time, so the risk of deflation is negligible. What this does is provide a boost to households’ disposable income and unless the current economic environment turns sour, it should result in increased levels of consumer spending. The interesting dynamic will be what impact it has on wage settlements which are a big focus for the Bank of England who have forecast wage growth to rise to over 3% this year and next.

“Currently, average wage growth is just 1.7% and with inflation of just 0.3%, employers have good reason to temper expectations of bumper pay rises. What will ultimately determine whether the MPC are correct in their forecasts is of course whether demand for labour begins to outstrip supply, giving employees the stronger negotiating position.

“For sterling, the outlook remains fairly positive with the economy in growth mode but May’s General Election is certainly a short-term concern with a hung parliament previously having seen it weaken sharply.”

What does it mean for pensioners?

Vanessa Owen, head of annuities and equity release at LV=, said: “The fall in the rate of inflation is great news for those concerned about the cost of living.  This is particularly important for retirees as they are often hit hardest by rising inflation. This section of society often spends a significantly higher percentage of their disposable income on bills, such as electricity.

“With people spending longer in retirement, the risk of inflation reducing the value of their capital is an issue that needs to be considered when deciding how to take an income from their pension fund, especially for those who are planning to take their savings as a lump sum.

“There are retirement solutions available that provide an element of inflation-proofing, yet the majority of retirees buy annuities on a level basis. However, since the Budget, we have seen this start to change, with those approaching retirement now looking for alternatives such as income drawdown, fixed term and investment linked annuities. We always encourage savers to shop around in order to make the most of their pension pots and achieve the level of income and flexibility they require.”

1 thought on “Inflation falls to record low: What it means for interest rates, sterling and more”

  1. Jive Bunny says:

    “If it turns negative this will be the first ‘deflation’ experienced in the UK since the 1960.” Really???!! Check this out – http://www.ons.gov.uk/ons/publications/re-reference-tables.html?edition=tcm%3A77-323617. Open the spreadsheet and click “RPI All items 1948 to 2014 1” then look at row 70 columns G thru N relating to 2009 months March to October 2009 and ol Ben thinks there hesn’t been deflation since 1960?? Er try 2009 Ben, the overall “inflation rate” for that year was -0.5%…..

    “Deflation is dangerous because it causes companies and consumers to do the exact thing that causes more deflation – delay spending in the hope of further price falls in future.” That’ll be why computers, TV’s and stereos etc, all of which have been falling in price since the 1990’s have been getting purchased all thru that time then !

    Are these people really “experts”?????

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