Hamish McRae: Low inflation is welcome news for consumers – and not so bad if you’re a saver

Falling current prices are a rare experience indeed

The Fawley oil refinery in Southampton. Big oil producers are the main net losers from falling prices (Getty Images)

If you think 0.5 per cent inflation is stunningly low, wait a month or two. It looks very much as though the consumer price index will actually go negative in the next couple of months, the first time it will ever have done so. Indeed the much longer series, the retail price index, has not gone negative since the middle of 1959, when it dipped briefly. Falling prices are a rare experience indeed.

Or rather falling current prices are rare. We have had plenty of experience of falling asset prices. In many parts of the UK house prices have yet to get back to their 2007 peak, while the FT100 share index is still shy of its all-time record of 6930 reached on 31 December 1999. And we have huge experience of falling commodity prices, for the driving force behind all this is, of course, the collapse of the oil price. The benchmark Brent price is now down to $46 a barrel, from as high as $115 in June, with predictions it could go below $40.

There will be an immediate political reaction to this as we are in the pre-election season. It could be billed as a success for the Coalition in that low inflation increases living standards. Since one of the main reasons why prices may be falling soon will be cuts in utility prices, it is awkward for the Labour leadership, undermining as it does the promise of a freeze on energy prices. And the “cost of living crisis” slogan becomes absurd if the CPI goes negative in run-up to the election. It would, however, be sad to see this in political terms. What is happening is a global phenomenon that has nothing to do with British government policy.

Any sudden price movement creates winners and losers, but on balance there are many more winners. UK living standards are rising now for just about everyone, about time you might say, and there is a direct impact on growth. The fall since last summer will add around 0.5 per cent to UK growth this year. There are net losers: the big oil producers including Russia, the oil production companies (the integrated oil majors can offset losses on the so-called upstream end of the cycle by making more money on the downstream), and in Britain, cities such as Aberdeen. Within Western Europe, Norway is the big loser. Were Scotland independent, it too would have faced great financial pressure.

But – and this is the big point – the world economy as a whole gains. We will come to see the fall in the oil price as hastening this recovery – the white knight on a charger arriving just in time to give it another two or three years to run.

There is, however, something else. We should not assume that prices will stay negative for long; just that inflation will stay low. The underlying level of inflation in the UK is around 1.5 per cent, and for the CPI to settle around there seems a reasonable expectation for the next year or two. If that is right, then it will change our attitudes and expectations in a number of ways.

For example, we will expect goods to be cheaper, or certainly no more expensive, next time we go to the shops. Indeed we already do, for that expectation is one driver behind the boom of discounters and the pressure on conventional supermarkets. Note the plight of Tesco and now Morrisons. If it changes the power balance between buyer and seller, it also changes the attitude to government. A local authority can’t put up parking charges and blame it lazily on general inflation. It means that central government does not get the revenue bounce it has come to expect. A world where prices don’t go up much is a world where tax revenues don’t go up much, or more accurately, they only go up if there is real growth as opposed to money growth.

It will also change attitudes to savings and investment. It should, as we adjust to the change, help both. True, people will have to hunt harder to get a real return on their savings, but at least the real value of those savings will not be whittled away by inflation – an insidious tax on prudence. Given the prospect of a month or more when the CPI goes negative, there is a much smaller chance of a rise in interest rates ahead of the election than there was six months ago. Rates will start to go up later this year but it now looks as though the first increase will come in the US, not here. So people who do have savings should feel a little more relaxed that they will start to get a better return on them.

A final point. A world where prices are reasonably stable is a world where investment decisions can be taken for real reasons as opposed to artificial ones. Inflation distorts. Those distortions can create windfall profits without any social benefit. They also may lead to windfall loses, which have to be priced into the cost of business. The long period of falling prices during the 19th century was also a long period of economic growth, technical advance and infrastructural investment. This dip does not mean we are back to the 19th-century experience by any means, for once the fall in the oil price moves through the system we will be back to inflation of close to 2 per cent a year.

In any case, I don’t think $45 a barrel oil is sustainable in the long run because the cost of production in so many of the fields is higher than that. But what has happened is a lucky break for the developed world at a tricky time – and a lucky break for battered consumers.