UK economy: inflation forecast to remain at 0%

Bank Of England Building

Falling oil prices and a strong pound are likely to have anchored inflation at zero for a second successive month in July, giving further reason for Bank of England policymakers to delay raising interest rates.

City economists said official figures to be published on Tuesday are likely to show consumer price inflation (CPI) remained at zero last month. The rate, which is used by the government as its official measure to set pensions, wages and benefits, fell to 0% in February, and has remained close to that level ever since.

It is now 18 months since CPI was at the Bank’s 2% target, and economists suggest it will not return to that level soon. The measure hit a low of -0.1% in April, and some analysts forecast that cuts in utility bills, and a fresh decline in petrol prices with retailers passing on recent falls in oil prices, could see it fall back below zero later in the year.

“Looking ahead, inflation is likely to turn negative again for a couple of months,” said Samuel Tombs of consultancy Capital Economics. “Supermarket competition should drive petrol prices down before long. In addition, British Gas will cut its gas prices by 5% in late August and other utility companies are likely to follow suit.”

Chris Hare, analyst at investment bank Investec, agreed. He said: “Our call on the CPI is that inflation will remain at zero in July, although we judge that there is a material chance that it will ease back into negative territory.”

Alan Clarke, of Scotiabank, said inflation may have nudged up in July, but only to 0.1%, despite a fall in petrol prices of about 0.7% on the month.

However, Kristin Forbes from the Bank’s monetary policy committe said yesterday that keeping rates at a record low when the economy was growing at its pre-crisis trend and earnings were rising at a robust pace risked “creating distortions” and “undermining the recovery”.

Writing in the Telegraph, she said: “Maintaining interest rates at the current low levels during an expansion risks creating distortions. Therefore, interest rates will need to be increased well before inflation hits our 2% target. Waiting too long would risk undermining the recovery—especially if interest rates then need to be increased faster than the gradual path which we expect.”

Oil prices have halved since last summer and the prospect of sanctions being lifted against oil-producing Iran, adding to the glut in supply, has pushed the price of Brent crude to below US$50 (£32) a barrel.

This fall has been passed on to consumers, and recent weeks have seen a flurry of price cuts on forecourts, with the average price of diesel falling to its lowest level in five years at less than 113p a litre. At some garages diesel now costs less than 108p a litre, and the RAC has predicted that it could continue to drop to below £1.

CPI

The strength of the pound – up by 20% over the past couple of years – is also putting downward pressure on CPI because it means imports are cheaper. The Bank’s last monetary policy summary, published at the same time as it announced its last decision to keep interest rates on hold, said the drag on import prices was expected to push down on inflation “for some time to come”. City analysts pushed their forecasts for the first rate rise since 2007 into next year – and possibly next summer – following the most recent meeting of the monetary policy committee, when just one out of nine MPC members voted for a rate rise.

The Bank concluded: “The near-term outlook for inflation is muted. The falls in energy prices of the past few months will continue to bear down on inflation at least until the middle of next year. Nonetheless, a range of measures suggest that medium-term inflation expectations remain well anchored.”

Historically low inflation has prevented the MPC from raising interest rates from their record low of 0.5%, despite relatively strong economic growth.

However, the Bank governor, Mark Carney, has suggested the decision to tighten policy “will come into sharper relief around the turn of the year”, prompting speculation of an increase at the start of 2016. Subsequently, Carney has stressed that this was a personal view, not the collective opinion of the MPC.

In an interview with the Sunday Times, David Miles, who steps down from the MPC this month, said that the case was building for a rate rise, despite inflation being likely to stay low.

Miles, who in six years on the MPC has never voted for a rise, said he had come closest to doing so at the last vote, but was put off by factors including falling commodity prices.

The economist, whose second term on the MPC finishes at the end of August, said there was “no great hurry” to raise rates, but with large parts of the economy “operating in a fairly normal way” there was a case for starting to increase rates.

“There is always a reason to delay but I’m wary about that,” he told the newspaper. “The stock of uncertainty is constantly being replenished.”

Powered by Guardian.co.ukThis article was written by Heather Stewart and Hilary Osborne, for The Guardian on Monday 17th August 2015 07.00 Europe/London

guardian.co.uk © Guardian News and Media Limited 2010

 

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