UK inflation declines to zero

Inflation in Britain declined once more in February, according to the latest release from the Office for National Statistics (ONS). Consumer price inflation dropped to zero per cent in February for the first time since records began. While comparable records only began in the late 80s, the ONS did suggest that inflation may have been lower in 1960.

The decline was a little more than consensus estimates of 0.1 per cent and means that inflation is now exactly two per cent away from the Bank of England’s (BOE’s) long-term target, which could give the bank more ammunition for cutting rates further, instead of raising them. However, this remains quite unlikely unless this period of low to zero price growth is more prolonged than thought.

“Despite inflation dropping to zero, it is unlikely we will see falling prices for a prolonged period, particularly as the pressure from lower oil prices fades,” said Rain Newton-Smith, the Confederation of British Industry’s (CBI) director of economics.

The UK’s government was quick to point out the benefits for households in Britain, as wage growth far outpaces price growth, meaning the average consumer effectively has more money in their pockets. George Osborne attributed much of the credit to the oil price crash, however, the ONS data also showed that food and transport costs also contributed to inflation falling to zero.

The real question is whether Britain is looking at a prolonged period of low to zero, or perhaps even negative, price growth. While living standards are set to increase in the near-term, if prices fail to begin increasing it could then start to impact wages negatively, which could result in deflation - much like the circumstances that led to Japan’s deflationary spiral.

It’s these conditions that is holding back the BOE from raising rates in the near-term, and has seen recent comments from BOE officials stress that the bank still has the option to cut rates further.

Only last week, Andy Haldane, chief economist of the BOE, said that rates may need to be cut again and that he believes “the chances of a rate rise or cut are broadly evenly balanced”.

Despite this, there’s a very low likelihood of another slash in interest rates, according to Howard Archer, chief economist at IHS Global Insight.

“An interest-rate cut still looks highly unlikely. It looks more likely that the Bank will hold off from raising interest rates until the early months of 2016 rather than act in late 2015,” he said.

For the moment, low inflation will be a boon to the UK economy and the recent ONS report sent the FTSE 100 index to a fresh record high in trading on Tuesday morning. Furthermore, the prospect of monetary policy remaining loose for the medium-term pressured the pound to the downside, where it hit a one-month low versus the euro.

The benefits of low inflation to the UK economy hinges on whether low to negative inflation remains for a couple of months or longer. But if this period extends further past a few months, the BOE may have to reconsider its next move.