November 20, 2014    3 minute read

UK Inflation: What Goes Down Should Be Going Up

   November 20, 2014    3 minute read

UK Inflation: What Goes Down Should Be Going Up

Official figures show that UK inflation, measured by the CPI, fell to 1.2% in September, a five-year low and down from 1.5% for the previous month. The ONS reported that lower transportation costs, particularly sea and air fares, and prices for recreational goods were the largest contributors. The BBC also cited lower energy and food prices as further enhancing the decline in the rate. According to Jeremy Warner of The Telegraph, had it not been for housing costs (rents and utility bills) UK CPI for September would have been just 0.8%. Furthermore, according to the British Retail Consortium, high street non food prices fell by 3.2% in September.

 Arguably the real issue facing the UK is that falling inflation has been a surprise. Central banks have been continually wrong-footed in their forecasts, and given the growing emphasis on forecasting or forward guidance in influencing consumer behaviour perhaps it is fair to say that if the guidance had been better we might not actually be in this position. Historically, very low interest rates (currently 0.5% in the UK) and high liquidity from significant levels of quantitative easing and easy consumer credit should be inflationary. The creation of easy money gives the consumer extra disposable income, which in turn fuels demand and pushes up prices. But history is not repeating itself. What is taking place all over the developed world is increased spending somehow leading to increased volume but lower prices.

 Perhaps there is a ‘perfect storm’ of counter-inflationary events taking place: reduced commodity prices, the legacy of the economic crisis of 2008 leaving under-financed businesses all too ready to cut prices to stay in business. However unemployment in the UK is falling so clearly jobs are being created, which only happens if people are purchasing goods and services. Yet much of the additional employment is low-cost low-skill (often in the form of zero-hours contracts), which does not do a much for the productivity of British business.

So what‘s the problem? Most people would argue that falling prices is a good thing. When innovation and improved efficiency deliver goods and services more cheaply to a “healthy” fully employed population, Jeremy Warner’s “good deflation” takes place. However when consumers postpone purchasing items today in the hope of purchasing them more cheaply in the future when the price goes down then deflation can be self-perpetuating. But this seems to be a misleading fallacy. The truth appears to be that the increase in poorly paid basic-wage or zero-hours employment only serves to mask the underlying dramatic decrease in skilled productive employment. Too many people are increasingly being condemned to low pay and low wage growth and the danger is that that may mask the real need in the UK economy for increased investment and innovation. Yet if our largest market, the EU, is itself struggling with deflationary low demand it may be a long and arduous road back.

Get articles like this straight to your inbox each morning with our Breakfast Briefing. Sign up by clicking here!

Log in with your details

or    

Forgot your details?

Create Account

Send this to friend