Following the Bank of England’s prediction in its February Inflation Report, the Office of National Statistics has announced that inflation has fallen to 0%[i].
In its earlier report, the Bank of England anticipated a short term negative inflation rate. This would be caused by the slump of oil prices impacting on motor fuels and tumbling food prices.
The last time the UK economy saw prices fall in this way was over 50 years ago, in March 1960[ii]. Successive governments have always taken steps to try to avoid high inflation rates. This is because they can have a destabilising effect on the economy leading to wage spirals and making forecasting difficult. This in turn can adversely affect business confidence. It also has a negative impact on people on fixed incomes who see the spending power of their money diminish.
But falling prices are not attractive either. Whilst high inflation causes the problems outlined above, the opposite – deflation – can result in prices falling to the point where people and businesses delay making purchases in the belief that they may get them cheaper if they wait. It follows that on a large scale this can cause growth in the economy to stop.
Deflation usually occurs when an economy is experiencing or is near a period of recession. Following lower demand for goods and services, prices, production and wages can fall causing a chain of events. Such a deflationary spiral (like spiraling inflation) can result in a loss of confidence by both consumers and business owners.
The good news is that the Bank of England believes that in the short term the fall in food fuel costs will result in higher consumer spending will stimulate growth and that we will return to a low rate of inflation. As a consequence the wider economy should not see a surge in bankruptcy levels or other insolvency procedures such as company administrations and liquidations.