The death of inflation
Bank split as UK teeters on the brink of deflation
UK inflation is dead. That was the verdict of one economist after official figures showed inflation fell from 0.3pc in January to zero in February. The reading was weaker than the 0.1pc expected by analysts and the lowest since March 1960, according to the Office for National Statistics. The so- called misery index – which combines inflation and unemployment – is now at its lowest level since records began in 1989.
David Cameron and George Osborne hailed low inflation as ‘good news for family budgets’ as the price of essentials such as food and fuel tumbles.
They will be hoping that the feel-good factor translates into votes at the General Election in May as they seek a Conservative majority. But the slump in inflation to zero – and its likely fall into the negative territory in the coming months – will raise eyebrows at the Bank of England.
Inflation has been below the central bank’s 2pc target since the start of 2014 and senior officials are at loggerheads over what to do about it. The big question concerns the outlook for interest rates which have been frozen at 0.5pc since March 2009 – spelling six years of misery for savers who are estimated to have missed out on £130bn of returns on their nest eggs.
Central banks traditionally raise interest rates to curb high inflation and cool the economy, and cut interest rates to drive up low inflation and stimulate the economy.
The financial markets expect rates to rise to 0.75pc next year and believe t he subsequent increases will be slow.
BUT Andy Haldane, chief economist on Threadneedle Street, last week warned that interest rates may need to be slashed again to stop inflation staying too low for too long. It put him at odds with other members of the nine-strong rate-setting monetary policy committee who have argued that rates are more likely than not to rise in the coming years as the economy recovers.
Until recently, two members of the MPC, Martin Weale and Ian McCafferty, were even voting for rates to rise immediately.
But taking on the consensus that has built up at the central bank, Haldane said ‘the chances of a rate rise or cut are broadly evenly balanced’.
He has yet to vote for a rate cut but says the MPC ‘needs to stand ready to move off either foot’. The comments appear to have left Haldane isolated at the central bank where the message is that ‘gradual and limited’ rate rises are on the way. Just days before Haldane’s speech, Mark Carney, the Bank’s governor, said it would be ‘extremely foolish’ to cut rates to counter a ‘temporary’ period of low inflation caused by an uncontrollable fall in the oil price.
Carney told Parliament that it would risk causing ‘ unnecessary volatility in inflation’ – adding inflation is likely to return to the 2pc target ‘within two years’.
But Haldane believes his colleagues may be underestimating the risks of deflation – exposing him as the central bank’s ‘ archdove’ and muddying the waters over the outlook for interest rates.
‘Rhetoric from key figures at the Bank suggests opinion about the risks faced by the UK economy is becoming divided,’ said Ben Brettell, senior economist at Hargreaves Lansdown. ‘A cut in interest rates looks most unlikely, but with inflation at zero and deflation looming it is almost impossible to see them rising either. It therefore appears interest rates will be stuck at 0.5pc for some time yet. I don’t see them rising until mid-2016 at the very earliest.’
In economic jargon, a ‘ hawk’ is someone who is worried that inflation will take off and leans towards higher interest rates while a ‘dove’ is less concerned about inflation and more worried about weak economic growth. Haldane’s dovish view has surprised observers who believe low inflation is good for the economy because it is as a result of the falling price of essentials which leaves families and businesses with more money to spend.
Many economists dismiss fears that Britain is heading for a dangerous bout of deflation where falling prices sap demand as people delay spending in the hope of cheaper goods and services in the future.
‘Three cheers for low inflation,’ is how Rob Wood, chief UK economist at Berenberg Bank, put it while Chris Williamson, chief economist at Markit, said that ‘rather than being a concern the drop in inflation is a boon to the economy providing households with greater spending power at a time when pay growth remains frustratingly weak’.
Wood went on: ‘Worriers might seize on this as evidence of a dangerous Japanese- style malaise stalking the economy, and inflation will very likely turn negative at some point i n the next f ew months.
‘But cheaper imports, petrol and food are unmitigated good news for consumers and growth. The UK can sit back and enjoy the purchasing power boost that low inflation today is bringing without fearing any of the sillier claims of what deflation might bring, like households delaying purchases on the expectation that prices will be even lower tomorrow.’
Haldane is clearly not so relaxed and in his own words is watching inflation ‘like a dove’.
But it could be a difficult few months for the central bank’s chief economist who, it would appear, no longer sees eye to eye with the rest of the MPC on the outlook for the British economy.