The UK has finally joined other advanced economies in experiencing deflation. This is a positive development and the risk that deflation becomes ingrained and so starts to have adverse effects remains very low. Indeed, deflation may last only one month. Capital Economics forecasts, CPI inflation eased from zero in March to -0.1% in April – the first time the measure has been in negative territory since 1960. Smaller increases in duties this April compared to those a year ago were partly responsible for the tick down in inflation. But the fall also reflected a statistical quirk relating to the timing of Easter. The ONS always records prices in the middle of the month. Prices in mid-April last year were boosted by the fact that Easter fell soon afterwards (Easter Sunday was on 20th April). Easter fell much earlier this year (5th April) and so had a less upward effect on the recorded level of prices. This helps to explain why airfares inflation slumped from 6.8% in March to -5.3%, knocking 0.1pp off the headline inflation rate. “Looking ahead, the UK’s deflation is unlikely to last long. CPI inflation should turn positive in May as petrol prices continue to rise and as the rate of food price deflation eases as the anniversary of very sharp falls in food prices are met” expects Capital Economics. At the same time, there are still no signs that very low inflation is at risk of becoming ingrained – consumers are undertaking, not delaying, purchases and nominal wage growth is picking up. Nonetheless, it is still likely to be another couple of years before CPI inflation returns to the 2% target. Price pressures at the start of the production pipeline remain very weak – note that producer output price inflation remained at -1.7% in April. In addition, the pound’s recent appreciation should ensure that import prices continue to fall. And the analysts remain optimistic of the scope for productivity to recover, ensuring that cost pressures within firms remain muted.So provided that the recovery in the oil price does not gather pace, inflation should remain comfortably below the MPC’s 2% target over the next couple of years, ensuring that households’ spending power continues to strengthen and enabling the MPC to raise interest rates at an extremely gradual pace.
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