Deflation, but good deflation

For the first time in over fifty years the UK has experienced consumer prices actually falling rather than rising and as a result sterling has headed lower by over 1% against the dollar. The data was less than expectations, in particular the core figure which strips out the more volatile energy prices, which came in at 0.8% well below the expected 1.0%.

Deflation would usually cause widespread panic and is more regularly associated with an economy in the depths of a recession, however this time things are very different where we find ourselves in a strange situation of strong growth, robust consumer confidence, rising wages and employment, but declining prices. We have been forewarned consistently for some time by the Bank of England (BOE) that there was every chance we could see a period of very low inflation or even deflation, so this does not come as any surprise, but due to the figure coming in lower than expected, it means pressure is on the BOE to keep interest rates low for longer.

Tomorrow’s BOE minutes will be closely watched to see if, as expected, the vote has remained 9-0 to keep rates on hold, but more interesting to see if there are still members who deem risks to be finely balanced. It wasn’t all that long ago, December in fact, when McCafferty and Weale had voted five times in a row for the BOE to hike rates, so even despite today’s deflation figure if these two members continue to express more hawkish tendencies, then it may not be long before they start repeating their voting pattern from the latter part of 2014.

We have seen similar conditions with our biggest trading partners in Europe where deflation has been a regular occurrence over the past few years and now with the ECB’s quantitative easing program in full flow, having also just moved up a gear ahead of the quieter summer months, we can see that this phenomenon is going to be temporary as the Eurozone recovers and the UK economy maintains its momentum.