UK on brink of deflation as Consumer Price Index falls to zero

But economists said that, although inflation is likely to turn negative in the coming months, the UK should avoid a damaging deflationary cycle with consumer spending set to benefit from the easing pressure on household incomes.

The latest fall in the Consumer Price Index (CPI) rate of inflation, from 0.3% in January, puts the UK on course for a period of falling prices for the first time in half a century.

February’s fall was a sharper than expected and sets a new record low for CPI since comparable records began in 1989.

Inflation is expected to dip further in coming months, with an experimental model created by the Office for National Statistics (ONS) suggesting that the last time it was negative was in March 1960, at minus 0.6%.

The surprise scale of February’s fall is likely to push back the expected timing of any increase in interest rates, currently pencilled in by most economists for 2016, putting downward pressure on the pound.

Rates have been held at 0.5% for six years but Bank of England chief economist Andy Haldane has said that in the light of low inflation the next move was as likely to be a cut as a rise.

Low inflation benefits consumers because it means their wages go further, but policy makers fear a prolonged period of negative CPI could have damaging effects.

That is because it is feared that deflation would cause consumers to delay spending and firms to put back investment.

At the same time, debt repayments such as mortgages would become more expensive in real terms.

This would threaten what Bank of England governor Mark Carney has described as a “clear and present danger” for the UK’s indebted households and businesses.

The Bank must to try to return CPI towards 2% and Mr Carney was obliged to write a letter of explanation to Chancellor George Osborne earlier this year when it fell more than 1% off this target.

Vicky Redwood, chief UK economist at Capital Economics, said today: “The UK is now within a whisker of deflation, with this morning’s figures showing that inflation fell from 0.3% to zero in February. This was a touch weaker than the consensus forecast of 0.1%, although in line with our own prediction.

“Lower petrol and gas prices shaved a bit off inflation. But the main driver of the fall was a drop in the core rate from 1.4% to 1.2%, probably reflecting the indirect effects of lower energy prices gradually feeding through.”

She added: “It looks odds on that inflation will turn negative in March, when the cut in gas prices by British Gas (the utility company with the biggest market share) will show up in the inflation figures for the first time. And inflation is then likely to remain around zero/slightly negative for the rest of the year.

“But we doubt that this will turn into more serious and engrained deflation, given that inflation expectations seem well anchored. We still think that deflation in the UK will be a ‘good’ development, giving households’ incomes a welcome boost and supporting the economic recovery this year.”

Rain Newton-Smith, the CBI’s director of economics, said: “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.

“While lower oil prices are cutting costs for businesses, and leaving households with more money in their pockets, North Sea oil producers are taking a hit. The measures to support the industry in the Budget will help address concerns over job losses and investment freezes, but it is not out of the woods yet.

“With the Monetary Policy Committee still alert to the risk of very low inflation becoming entrenched, a rise in interest rates anytime soon seems off the cards.”

James Sproule, chief economist of the Institute of Directors, said: “We welcome the news that inflation has once again fallen. It is particularly encouraging that this has been driven by falling fuel costs. This is putting extra spending power directly into people’s pockets and is acting as a further catalyst to economic growth.

“Looking to the longer-term, we are encouraged that IoD members are planning pay rises for their staff in 2015. In the majority of cases these will be tied to improved corporate performance. This is the sort of responsible decision which will ensure economic growth is sustainable.

“However, low inflation does mean that Governments must be that much more careful with decisions on tax and spending, as very low, or zero, inflation means miscalculations cannot be eroded in future years by inflation. An incoming government must be very aware that they will have to live with any changes to tax rates or thresholds for the long term.”