In a gloomy report, the Centre for Economics and Business Research (CEBR) predicts that inflation in the UK will fall to minus 0.2 per cent in the year 2002 after slowing to 0.2 per cent in 2001.
The fall in prices - also known as deflation - will be accompanied by a rise in unemployment of more than 500,000 over the next three years, while interest rates will fall to as low as 2.4 per cent.
The CEBR has revised its forecasts following signs of weakening consumer confidence and figures showing that companies are sitting on an unexpectedly large amount of excess stock.
Companies will cut prices to sell off excess stock just as demand is weakening, while falling oil and commodity prices will add to the downward pressure on inflation, the CEBR says. That is likely to result in lower pay rises.
Douglas McWilliams, chief executive of the CEBR, said: "Inflation took off in the 1970s on the back of inflationary wage increases and rising oil and commodity prices. Now all these factors are going into reverse, and as a result inflation is likely to disappear.
"This will be a new world for most people working today, who have spent their entire working lives in an inflationary environment. We will no longer be able to think in terms of annual rounds of wage and price increases."
The CEBR predicts a gradual fall in base rates from 7.2 per cent this year to 5.3 per cent next year, 4.2 per cent in 2000, 2.8 per cent in 2001 and 2.4 per cent in 2002. It warns that the economy is set to shrink slightly: real gross domestic product growth will fall from 2.4 per cent in 1998 to minus 0.1 per cent next year before returning to growth of 2.3 per cent by 2002.
Technically, the forecast of negative inflation applies only to 2002, but the CEBR predicts that the phenomenon of deflation may persist beyond then.
The fall in prices would be the first since the 1940s. The lowest rate of UK inflation in the past four decades was in 1959, when prices rose 0.6 per cent.Reuse content