UK inflation halves to 0.5% giving Bank of England headache of interest rate hikes and deflationary fears

UK inflation has fallen to its lowest level since the turn of the century, as falling petrol prices and an ongoing supermarket price war contribute to an increasingly hostile economic climate for any prospective interest rate hike.

Halving to 0.5% between November and December, the consumer price index (CPI) has been affected significantly by tumbling fuel and food prices, with economists quick to point out that these could be temporary issues rather than outright causes of deflation.

When the prices of energy and food, two innately unpredictable entities, are excluded core inflation increased 0.1% from November to December, implying a lack of deflationary pressure across all the UKís industries, for example alcohol and tobacco prices were up over 0.2% for December.

The Bank of England has expressed that it is likely inflation will drop further as oil prices, currently standing at roughly $46 a barrel, continue to plummet, and Governor Carney has said it would not be ridiculous if core inflation went negative for the first time since the 1960s.

However, negative inflation is not immediate cause for concern, as alongside fuel and food prices falling, the cost of electronics and other products will fall as well, giving households the chance to invest in affordable necessities.

In his speech made today, George Osborne will seek to alleviate any fears of deflation, and detract from any correlation being formed between the UK and certain countries in the eurozone undergoing deflation at present.

He is expected to say: ìThe low inflation we see here in the UK ó driven as it is almost entirely by external factors such as the oil price ó is much more welcome than in the eurozone where inflation has been very low for some time and is now negativeî.

He will add: ìWe should not confuse this welcome news for Britainís households as a result of falling oil prices with the threat of damaging deflation that we see in the eurozone.î

One positive to certainly take is the impact of falling inflation on real wages, with growth in incomes standing at 1.6% at present. Workers could benefit from a protracted period of real wage growth, and alongside this, government are attempting to style falling inflation as an unexpected tax rebate for consumers who can enjoy great savings as a result of reductions to the price of a variety of goods.

Shabana Mahmood, Labourís shadow Treasury minister, was insistent that government ought not to take credit for the incidental nature of falling inflation. She said: ìPlummeting global oil prices are the reason why the rate of inflation is falling here in Britain. But wages continue to be sluggish and the squeeze on living standards since 2010 means working people are £1,600 a year worse off under this government.î

Many analysts are revising their predictions for an interest rate hike, pushing them back to 2016 from the middle parts of this year. As a result of core inflation falling under a percentage point below the Bank of Englandís 2% target, Mark Carney has conceded that the record low base rate will be kept the same for a longer period of time due to external factors i.e. falling oil prices.

Martin Beck, senior economic advisor to the EY ITEM Club, said: ìWe would be surprised if the MPC will want to raise rates while inflation is very low. With inflation set to be below 1% for almost the whole of 2015, we do not expect the first rise to come before early 2016.î

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