Bank of England says Britain set for deflation for the first time since 1960

The MPC now judges it more likely than not that headline CPI inflation will turn negative in the spring

Britain is heading for consumer prices deflation for the first time in more than five decades, the Bank of England said yesterday.

The inflation rate as measured by the consumer prices index (CPI) slumped to just 0.5 per cent in December on the back of collapsing global oil prices. The Bank said its Monetary Policy Committee (MPC) “now judges it more likely than not that headline CPI inflation will turn negative at some point in the spring and will remain subdued for much of the rest of the year”.

However, the Bank’s Governor, Mark Carney, also said deflation in the UK was “unlikely to endure for very long” and stressed it was different to the destructive deflation that has ravaged the Japanese economy for much of the past two decades.

Mr Carney added that falling energy and food prices would support household incomes and boost the growth of real take-home pay this year to its fastest rate in a decade.

The CPI has been the Bank’s official target measure of inflation since 2003 and the official statistical series only goes back to 1989. But an experimental model created by the Office for National Statistics last year produced a longer record of inflation using CPI. The last time inflation, on this measure, was negative was in March 1960.

The Bank’s forecasts show CPI hitting zero in the second quarter of the year and hovering around that level until the final quarter, when it picks up. Mr Carney said that if deflation proved more stubborn than expected, the Bank could counteract it by slowing the pace of rate rises, implementing more asset purchases, or even cutting rates below  0.5 per cent.

In the past the Bank has said that further cuts in rates are impractical, but the Governor suggested yesterday that banks and building societies were now sufficiently well capitalised to cope with the hit to their profits that lower interest rates would inflict.

 

However, the Governor stressed that the public and businesses should prepare for the next move in official rates being up rather than down.

Financial markets interpreted his remarks as being relatively hawkish in terms of the direction of monetary policy. Sterling strengthened by one and a half cents against the dollar yesterday, hitting $1.5384. The pound also rose half a cent against the euro to $1.3492.

Mr Carney said there was also a chance that the drop in oil prices would provide a greater than expected stimulus to consumer spending and pose the risk of inflation overshooting its target. “If these risks were to materialise, it could be appropriate for Bank rate to rise more quickly than implied by current market yields.”

Vicky Redwood of Capital Economics, the consultancy, said: “With the MPC fairly relaxed about the prospect for deflation, we still think there is a reasonable chance of a hike before the end of this year.”

The latest forecasts come just ahead of the sixth anniversary of rates falling to a record low of 0.5 per cent. MPC members Ian McCafferty and Martin Weale abandoned calls for a rise in January.

The Bank’s official target is to keep inflation growing at  2 per cent. It said that two thirds of the present shortfall against this target was due to the plunge in energy prices, which have roughly halved since the summer, while a third was down to weak growth in domestic prices. It forecast GDP growth in 2016 of 2.9 per cent, up from its November forecast of 2.6 per cent. The 2015 forecast of 2.9 per cent was unchanged.

The Bank revised up its average forecast  for nominal wage growth in 2015 to 3.5 per cent, from 3.25 per cent last time. Wage growth in 2016 was also revised up, with the Bank saying this will be a consequence of stronger GDP.

The most dramatic revisions were in real post-tax household incomes, which benefit from both stronger wages and lower inflation. The Bank now sees these growing by 3.5 per cent in 2015, up from 1.25 per cent in November. “This will support solid growth in consumer spending” said Mr Carney.

The Bank’s business investment growth forecast for 2015 was revised down from 10 per cent to 6.25 per cent, with the Governor identifying weaker North Sea capital spending. But it is still seen as accelerating to 8.5 per cent in 2016.

Sea of negativity: Sweden latest to push rates below zero

Sweden became the latest country to push its interest rates into negative territory yesterday in order to fight the scourge of deflation. The Riksbank cut its main policy rate from 0 per cent to a new record low of minus 0.1 per cent.

The country has been grappling with negative inflation since the beginning of 2013.

A growing number of monetary authorities are experimenting with negative rates. The European Central Bank has cut its deposit facility to minus 0.2 per cent to discourage banks from parking money with the Frankfurt-based lender of last resort.

The Swiss National Bank slashed its main rate to minus 0.25 per cent in December in an effort to deter “safe haven” capital flows into its banks.

And the Danish central bank, which has the job of pegging the local currency to the euro, has gone deep into negative territory to pursue this goal. It has cut rates four times since the beginning of the year and they currently stand at minus 0.75 per cent.

The objective of negative rates is the same as cutting them: to stimulate growth and inflation by encouraging borrowing and discouraging saving. 

FIH Erhvervsbank of Denmark  is planning to charge retail customers to hold money in their deposit accounts.

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