UK threatened by deflation: Expert reactions

12th February 2015

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Driven by falling oil and food costs UK inflation is set to fall into negative territory.

In the Bank of England’s Inflation Report, governor Mark Carney asserted that inflation is likely to “fall further, potentially turn negative in the spring, and be close to zero for the remainder of the year”.

READ MORE: UK inflation to turn negative this year says Bank of England boss

Inflation is now at its lowest level in the UK for the past two decades, with the latest reading showing that the cost of living has collapsed to 0.5%.

We round  up the latest reactions to the Bank’s news…

David Curtin, fixed income portfolio manager at BlackRock:

“The Bank of England’s inflation report was surprisingly upbeat. The lowering of the labour market slack estimate and the increased growth forecasts indicates confidence in the UK economy, illustrated by the expectation of pickup in wage growth continuing.  This should stave off the threat of prolonged disinflation.

“The report has bolstered our positive view on the UK economy. In the euro area, we expect that over the course of the year, peripheral assets will perform well.  However, the Greek debt relief negotiations may cause a delay to the positive economic story playing out in the UK market place. Nonetheless the UK remains a strong investment story.

“We do not expect the UK to join the recent trend for central banks globally to lower interest rates.  We expect further gains in the labour market in coming months, and a strong consumer to drive the economy forward.”

Nick Dixon, investment director at Aegon UK:

The Bank of England may not be showing much concern over stalling inflation, as low food and oil prices are generally considered to be supportive of economic growth, but there seems to be grounds enough for the dovish members of the central bank to be even looking at an interest rate cut.

The threat of deflation, together with sterling’s gains against the euro, have created an unexpected challenge for the BoE, and we could see a 0.25% interest rate, and even a reinjection of quantitative easing, before the year is through.

TUC general secretary Frances O’Grady:

This forecast should be a wake-up call to government. The Chancellor has already delivered the slowest recovery in British history along with dramatic falls in living standards. Deflation would be no surprise in Britain’s slow growth, low pay economy, and would pose real risks to future growth and living standards.

Responsibility for stabilising inflation cannot be left to the Bank alone. The government must come up with a credible plan to get wages rising faster. And the Chancellor should stop threatening the economy with the biggest austerity package in the developed world.

Helal Miah, investment research analyst at The Share Centre:

In its statement this morning, the Bank of England said that it expects inflation to turn negative in the coming months, mainly due to the plunge in oil prices. Furthermore, it does not predict that inflation will reach the 2% target until 2017. However, as a result of the UK economy remaining robust and predictions that oil prices will slowly recover to $70 a barrel, investors should note that it believes deflation will only be temporary and inflation will pick up in the second half on 2015.

On the back of this news and Marc Carney’s comments seeming slightly more hawkish than in the past, sterling has made modest gains suggesting that the first interest rate rise may happen a little sooner than markets had anticipated but still around early 2016.

It does seem however, there is a risk that low inflation could last longer than predicted. In this scenario, the Bank of England will look to provide support to prices if low inflation became self-supporting. As a result, there may be the possibility of it boosting QE further or cutting the benchmark interest rate.

“This inflation report does not signal any major changes from what we already knew. Therefore, in this environment we feel that the equity market still represents the most attractive asset class for investors. This is due to good real incomes and the prospect of capital growth, as the economy continues along the path to recovery.

Ben Brettell, senior economist, Hargreaves Lansdown:

In its Quarterly Inflation Report released today, the Bank of England admitted inflation is more likely than not to turn negative in the coming months because of the falling oil price, and would remain close to zero for the rest of the year. However, Mark Carney’s letter to the Chancellor stressed that this was temporary and does not mean the UK is experiencing deflation. The Bank expects inflation to return to target in two years and then creep slightly higher.

In many ways Mark Carney’s letter is the opposite of the letters his predecessor Mervyn King had to write. King needed to explain that above-target inflation was being caused by external factors, and that raising interest rates in response would risk the recovery.

The sharp dip in inflation reflects the nature of year-on-year figures; as prices are compared with one year ago, one-off factors like the oil price slide can have a large impact. However, as they drop out of the figures the rebound effect can also be exaggerated. In 12 months’ time, the inflation numbers will compare fuel prices with today’s low base.

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.

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