April’s inflation figures were the first in six months that didn’t beat expectations. The annual rate of consumer price inflation (CPI) fell to 2.3% in April. That was still above the 2% target, but down from 2.9% in March, as energy prices and food costs eased. The retail price index (RPI), which includes housing costs and is widely used for wage negotiations, slid further into deflation, falling by 1.2% in the year to April, the lowest figure since records began in 1948.
Inflation will fall further
The figures are a reminder that “excessively low inflation, and perhaps even deflation”, are the key risk over the next year or two, according to Capital Economics. Inflation is expected to slide further as year-on-year petrol prices fall. The recession will also lead to rising spare capacity and falling demand amid soaring unemployment and low wage growth. RPI’s slide will reinforce the downward pressure on wages stemming from low corporate profitability and rising unemployment, with many facing “wage freezes or even pay cuts”, said Howard Archer of HIS Global Insight.
What next?
A prolonged period of deflation raises the spectre of a “hellish circle”, said Ian Campbell of Breakingviews. Stagnant or falling wages will combine with rising real debt burdens, leading to lower spending, which results in higher unemployment, which further hits demand and prices. But not everyone believes it’s a real threat. Deflation looks like a “bogeyman”, said Liam Halligan in The Sunday Telegraph. In the Bank of England’s February inflation report, “the dreaded d-word received top billing”. Yet last week’s report didn’t mention it. The Bank has also raised its inflation forecast for the end of 2010 to 1.5%.
One point to consider is that the credit crunch has restricted supply in the economy as firms without access to credit have folded, leaving competitors with more pricing power. “The rise in spare capacity isn’t as large as you would think simply from the projections of growth,” said the Bank’s deputy governor Charlie Bean.
Oil prices have rebounded sharply, implying higher petrol prices; the VAT decrease is scheduled to be reversed next year, which will also bump up CPI; and the fall in sterling has pushed up import prices. The Bank has also been printing money (quantitative easing, QE), stoking up future price pressures. So inflation could rise when things improve and the Bank could fail to rein in QE in time to keep a lid on price rises, said Anthony Hilton in the Evening Standard. In two years’ time, “inflation could be a major concern”.