Market View: Deflation will be avoided

Deflation will be avoided, but CPI inflation will fall below 1 per cent in the coming months, economists have predicted.

CPI inflation dropped to 1 per cent in November, data has revealed, which was much larger than the consensus expectation of a fall to 1.2 per cent.

The latest data from the Office for National Statistics showed the rate of annual inflation was 1 per cent in November, down from 1.3 per cent in October, which is its lowest level in 12 years.

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Paul Hollingsworth, UK economist at Capital Economics, flagged up that given the 2.5 per cent monthly fall in petrol prices, it is “unsurprising” that one of the largest contribution to the fall in CPI was transport.

Looking ahead, the recent 25 per cent fall in oil prices to below $60 (£38) per barrel, from their average level of $79 (£50) in November, will cause petrol’s contribution to CPI inflation to decline by another 0.3 percentage points.

Mr Hollingsworth added that the freezing of energy bills this winter should mean that energy prices’ contribution to inflation falls from 0.3 percentage points to zero in December.

“Accordingly, while for now we think that outright deflation will be avoided, it is clear that inflation is set to fall significantly below 1 per cent over the coming months and is likely to act as a significant brake on the pace of monetary tightening over the next couple of years.”

Ben Brettell, senior economist at Hargreaves Lansdown, agreed that the fall to 1 per cent did not come as that much of a surprise. “A fall below 1 per cent now looks likely, but the resulting letter of explanation from [Bank of England governor] Mark Carney to the chancellor should be relatively easy to write.

“A reduction in fuel costs is good news for the UK economy, and can be seen as broadly analogous to a tax cut. It should ease the pressure on household budgets and boost consumer spending.”

Neil Williams, Hermes’ chief economist, commented: “Today’s data were an early Christmas surprise, and, by turning out softer than expected, will pare back most investors’ RPI and CPI projections for 2015.

“My inflation model now predicts just 1.7 per cent average RPI inflation for 2015, with the policy-sensitive CPI inflation averaging just 0.9 per cent next year.”

He added that the UK now has overall goods-price “deflation” after taxes for the first time since 2007.

“The overall headline CPI targeted by the BOE is being held up only by stickier service prices (2.4 per cent year on year). These being relatively more demand inelastic suggests at least some inflation resistance to firmer pound going forward.

However, Hermes’ model predicts the CPI will now trough as low as 0.3 per cent year on year in February 2015, with Mr Carney having to write his first letter to George Osborne.

Williams added that: “We still at this stage have two 25pb rate hikes in mind for the back end of 2015 (one August, one November), which would cap the CPI’s bounce-back at 2 per cent by Christmas 2015.