UK Inflation Zero

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London – Inflation rate has fallen to zero this year in February for the first time since comparable records began in 1989, and it will supposedly remain this low throughout 2015.

Although low inflation rates are widely welcome by consumers as generally consumer goods prices decrease, giving people the feeling of being ‘richer’, inflation and deflation are complex phenomena which are interlinked with international socio-political events.

What zero inflation means for the people living in the UK is thus to measure against the global effects of such economic fluctuations, and, most importantly, to be carefully analysed in order to make predictions and avoid negative effects.

In economic terms, inflation is a sustained increase in the general price level of goods and services in an economy over a period of time as measured by some broad index (such as the Consumer Price Index). When prices rise, each unit of currency buys fewer goods and services, reflecting a reduction in the purchasing power per unit of money.

 

What has been happening since late 2014 in the UK is the opposite trend, or deflation, that is a decrease in the general price level of goods and services which reflects an increase in the purchasing power per unit of money.

 

Specifically, the zero inflation rate of February resulted from two interlinked factors – the fall in oil prices, and the so called supermarket price war. The former factor mirrors the political decisions of the major oil producing countries – in particular Saudi Arabia – which is influencing economic fluctuations on a global scale, and in particular the economies of the greater oil importing countries and those of minor oil exporters.

 

The latter is the result of a fierce competition between big grocers (namely Morrisons, Sainsbury, Tesco and Asda) and discounters Lidl and Aldi. As a result, food prices – including milk, vegetables, meat and bread – have plummeted, and so have the prices of gardening tools, games, books, laptops, tablets and computer peripherals.
The most apparent consequences of this deflation wave are a decrease of the energy prices leading to a reduction of fuel and transportation costs and households costs as gas and heating become cheaper. Combined with the decrease of food costs, energy price decline makes people feel a bit ‘richer’ as their purchasing power is increasing. Furthermore, wage growth was running at 1.8% at the start of the year after 8 years of decline due to rising inflation. Generally these consequences are regarded as positive, leading to economic growth by boosting spending especially in household goods such as clothing and footwear.

Nevertheless, even if these unstable factors – energy and food prices – are not considered in the inflation picture, says Maike Currie, associate investment director Fidelity Person Investing, the core inflation is declining from last December (1.3% in December to 1.4% in January to 1.2% in February), and were it to decline even further throughout the year, it could possibly turn the ‘good disinflation’ into an ‘unhealthy, fully fledged deflation’, a situation which would be worrying.

As a matter of fact, unlike temporary zero rate inflation (or disinflation), a fully fledged deflation would not be beneficial to any economy as the stagnation of prices would discourage people from buying things they normally can buy at any moment (e.g. cars, washing machines, etc.), and rather wait for the prices to go even further down.

Furthermore, in a phase of deflation, to compensate the decreasing income companies would cut costs through wage reduction and layoffs which, in their turn, would decrease spending even further. In other words, if deflation lasts for too long or is too severe, it will establish a vicious circle preventing economic growth. Experts assure this won’t be the case for the UK, and think that the consumer demand will remain stable in the face of falling prices because of the increasing wages and employment growth.

 

So the UK is not on the brim of a disastrous deflation, say experts pointing out that inflation in the service sector (80% of the UK economy) remains firmly above the government’s 2% target.

Nevertheless, although no concrete measures have yet been taken, Bank’s chief economist Andy Haldane says he can contemplate voting to cut official interest rates to boost the economy.
Therefore, for the moment the UK is apparently facing a positive phase, and economists are not excessively worried. This welcomed disinflation happens just before the 2015 UK General Election, and will certainly have an impact on the results.

As a matter of fact, the unchanged cost of living combined with the 1.8% increase in wages seems to give a pre-election advantage to Coservatives with regards to austerity measures and their possible slackening. Chancellor Osborne said that zero inflation was “good news for families”, directly inserting the economic fluctuation into the pre-electoral discourse and the present welfare into Conservatives’ economic plan as explained in the Budget. On the other hand, Labour’s shadow Treasury minister Cathy Jamieson is more skeptical: “a few months of falling world oil prices won’t solve the deep-seated problems in our economy”.

After many years of recession the UK economy seems to sigh with relief, and yet economists are carefully monitoring the economic fluctuations to make plausible predictions and avoid negative consequences. It remains to be seen how the future Parliament will tackle this issue and maintain the 2% inflation target after the election.

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