UK sliding towards first bout of negative inflation in 55 years
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Version 0 of 1. Britain is sliding towards its first bout of negative inflation in more than half a century, the Bank of England has said, but strong economic growth should stave off the threat of a deflationary spiral. The slump in oil prices and falling food prices is likely to push inflation to zero in the second and third quarters of 2015, probably dipping into negative territory for one or two months this spring, the Bank said in its February inflation report. But the Bank also revised up its forecasts for growth in 2016 and 2017, helping push sterling to a seven-year high against the euro, with one euro worth 73.71p. The pound also rose 1% against the dollar to $1.5388 as investors bet on a rate hike coming sooner than expected, later this year or in early 2016. UK inflation was 0.5% in December, well below the Bank’s 2% target. Speaking as it published its latest quarterly inflation report, the Bank’s governor, Mark Carney, said: “It will likely fall further, potentially turn negative in the spring, and be close to zero for the remainder of the year.” The last time headline inflation was negative in Britain was March 1960, according to the closest comparable data from the Office for National Statistics. The Bank expects the slump in oil prices and falling food prices to keep inflation low in the short-term. However, lower oil prices – which have more than halved since last summer – are expected to significantly boost consumer spending. This in turn should fuel growth and push inflation higher over the medium term. Related: Will below-zero inflation lead the Bank to start tightening policy? “The combination of rising wages and falling energy and food prices will help houseshold finances and boost the growth of real take home pay this year to its fastest rate in a decade. This will support solid growth in consumer spending,” Carney said. He described the sharp fall in oil prices as “unambiguously positive” for the global economy and for the UK, and said the public should be prepared for an increase in borrowing costs. Rates have been on hold at an all-time low of 0.5% since March 2009. “The most likely next move in monetary policy is an increase in interest rates. The message is clear,” Carney said. Vicky Redwood, chief UK economist at consultancy Capital Economics, said: “The Bank of England’s latest inflation report has confirmed that the monetary policy committee thinks that deflation is now on the horizon, but that this will be fairly short-lived. “With the MPC fairly relaxed about the prospect for deflation, we still think there is a reasonable chance of a hike before the end of this year.” Published alongside the inflation report was a letter from the governor to the chancellor, George Osborne, explaining why inflation had missed the government’s targets. Carney said: “Inflation pressures could be greater if lower oil prices were to provide greater stimulus to global and domestic growth or if slack in the economy were to be absorbed more quickly than in the central projection. “If these risks materialise, it would be appropriate for Bank rate to increase more quickly than embodied in current market yields but the likelihood is that those increases would still be more gradual and limited than in previous tightening cycles.” Martin Beck, senior economic advisor to the EY Item Club, said: “One of the most notable changes to the Bank’s forecast is the upward revision to the inflation profile towards the end of the forecast horizon. “This reinforces our conviction that interest rate rises, while likely to be very gradual, will probably increase at a faster pace than the market expects. We expect the first hike to come in early 2016 and for rates to reach 1% by end-2016 and 1.5% by end-2017.” The Bank left its 2015 economic growth forecast unchanged at 2.9%, but raised its forecast for 2016 to 2.9%, up from 2.6% three months ago. It also raised its forecast for 2017 to 2.7% from 2.6%. Carney warned in his letter to Osborne that if low inflation persists for longer than expected and the global economy is weaker, the Bank stands ready to cut interest rates further and pump more money into the economy through quantitative easing. “To the downside the fall in near term inflation could be more persistent than the committee currently expects. In that case the MPC would need to provide more support to returning inflation to the target over the appropriate horizon.” One option would be an even more gradual increase in interest rates than the City expects but, Carney added: “The committee could also decide to expand the asset purchase facility or to cut Bank rate further towards zero.” The governor played down the risk posed to the UK by a potential Greek exit from the euro. “Would it have the same impact on the UK economy as it would have done in 2012? No.” He conceded the impact would be negative, but said the UK today would be better protected than it was three years ago, partly because the UK banking system is more resilient and because UK financial exposure to Greece was minimal. |