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The UK Enters Deflation

After spending several months hovering on the brink, the UK finally slipped into deflation for the first time since March 1960 during April. Consumer Price Index inflation dropped at an annualised rate of -0.1% in April, according to the Office for National Statistics, pulled down by lower transport costs, a steep fall in the price of oil, the strength of sterling and intense competition among food retailers.

The Bank of England had anticipated the UK would fall into deflationary territory in the short term and inflation is expected to rebound towards the end of the year. Governor Mark Carney has stressed that “a temporary period of falling prices should not be mistaken for the potentially damaging process of widespread and persistent deflation”, and the Bank of England expects inflation to reach its government-set target of 2% within the next two years.

Other countries elsewhere in the world – particularly in the eurozone – are also experiencing deflation, caused primarily by dramatic falls in energy prices. Nevertheless, because its underlying fundamentals are generally robust, the UK is not expected to languish in deflation for long and, amid signs the oil price has started to stabilise, inflation is widely expected to rebound. Moreover, as this period of deflation is expected to prove only temporary, it might actually help to provide an additional boost for the UK economy as consumers take advantage of rising wages alongside falling prices. So far, there is no evidence to suggest British consumers are delaying purchases in the expectation prices will continue a sustained decline.

The British Chambers of Commerce (BCC) does not see any “real risk of a prolonged period of deflation in the UK”, highlighting a recent rebound in oil prices. Nevertheless, it regards an environment of continued low inflation as “good news” for both businesses and consumers. Looking ahead, the BCC believes inflation will rebound to 1% by the end of 2015, and will approach its 2% target by early 2017, providing plenty of scope for the Bank of England to maintain low interest rates. Meanwhile, the Confederation of British Industry (CBI) hailed the effect of falling oil prices as “good news” that has helped to boost household incomes and reduce costs for many businesses. Looking ahead, the CBI expects interest rates to remain low into 2016, providing additional support for the UK’s domestic recovery.

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