Several outspoken economists have gone against the grain and claimed the trend of falling prices in the UK could result in growth-boosting, “good deflation” for the country.
Many economists are now predicting the UK will enter into deflation in the coming months, following a drop in inflation to 0.5 per cent in December from 1 per cent in November.
But the traditional narrative that deflation is a bad thing for an economy has been rejected by some.
David Page, senior economist at Axa Investment Managers, said inflation “looks likely to dip to a negative year-on-year rate in February”.
However, he predicted the emergence into deflation would be temporary, with its overall low point set to be in February or March, depending on the movement in the price of oil.
Azad Zangana, senior European economist at Schroders, said inflation should fall further because the drop in the price of oil had yet to be fully fed through to household energy costs or the cost of fuel.
Energy supplier Eon said last week it was lowering its prices by 3.5 per cent, which could encourage others to follow suit.
There is also growing political pressure on energy companies to lower their prices to help consumers.
This boost to consumer spending has been cited by some economists as the pivotal reason as to why deflation in the UK should be viewed as a positive development.
“While the low headline inflation rate would ordinarily be seen as a sign of weakness in an economy, the external shock of low oil prices is likely to boost the disposable income of households, encourage greater spending and raise economic growth for 2015,” Mr Zangana said.
Vicky Redwood, chief UK economist at Capital Economics, which also expects the rate of inflation to be -0.1 per cent or -0.2 per cent in February and March, said it should be the “‘good’ type of deflation, which will give a boost to the economy”.
Ms Redwood cited the fact that ‘core’ inflation – which excludes the energy sector, food, alcohol and tobacco – actually rose in December, from 1.2 per cent to 1.3 per cent, as evidence that any deflation would be based on temporary factors.
“It will be deflation in a purely technical sense, rather than a damaging and prolonged, debt-deflation spiral,” she said.
“So rather than being something to worry about, we think deflation would be a positive development, which would boost households’ and firms’ spending power.”
Deflation is generally viewed as a negative for economies because when prices are falling, people tend to defer spending in order to wait for a lower price, which leads to lower economic growth.
But the nature of the expected deflation, and the fact it should be very brief, meant the reverse could happen, according to some economists.
Guy Foster, group head of research at Brewin Dolphin, said the rise in core inflation while headline inflation fell “reflects a fall in bad inflation – the kind that eats into consumers’ incomes – while good inflation remains positive”.
He said upcoming wage data should now show earnings growth outpacing inflation.
“This looks unambiguously positive for consumption in the UK, Europe and Asia, which have all habitually transferred their wealth to oil-producing countries in recent years,” he said.
However, Scott Jamieson, head of multi-asset at Kames Capital, warned the rate of inflation had been “slipping steadily for some time now”, long before the oil price began to fall.
He said this highlighted that there were still a number of issues blighting the UK economy, such as the lack of wage growth.
Emergence into deflation may not stop Carney raising interest rates
The decline in the rate of inflation, and a possible move into deflation, may not stop the Bank of England (BoE) from raising the UK’s base interest rate this year, according to experts.
The fall in inflation is expected to put pressure on the central bank to hold off on a rate increase, which is generally seen as a disinflationary measure.
But given the temporary nature of the drop and the boost to growth that is expected to come from the falling price of oil, experts have suggested BoE governor Mark Carney could ignore them and stay the course.
Schroders’ Azad Zangana said: “The bank could still consider raising interest rates this year, particularly if we see another year of strong growth – now more likely thanks to falling oil prices.”
And Capital Economics’ Vicky Redwood said she was “maintaining our forecast of one interest rate rise in the second half of the year”.
