Deflation fears as retail prices drop for first time since 1960

It's official: the retail price index has slipped into negative territory for the first time in 50 years...

Last Updated: 31 Aug 2010

The Retail Price Index dropped by 0.4% in March, according to Government figures released this morning – the first time that it’s fallen since 1960, as plunging interest rates have dragged down mortgage payments. And although the Consumer Price Index (the Government’s preferred measure of inflation, which strips out housing costs) only fell to 2.9%, still ahead of target, it’s very definitely heading south too. So although most of us will actually be quite enjoying the fact that prices are lower, the Bank of England will be fretting about how to stave off deflation…

The RPI has now fallen from 5% to below zero since last September, and it’s largely because we’re paying a lot less for our mortgages. As the housing market has dived and the Bank of England has slashed interest rates, repayment costs have tumbled – indeed, if you strip out this factor from the index, RPI was actually up 2%. This has put more money in our pockets in the short term, which is good; but lower interest rates also mean we make less money from our savings, which isn’t. It’s also bad news if you have a salary review coming up, since RPI is often used to adjudicate pay disputes.

Meanwhile the Consumer Price Index continues to prove more resilient than people expected – at 2.9% (down from 3.2% in February, thanks largely to lower fuel bills), it remains well ahead of the Bank’s 2% target. Governor Mervyn King has suggested that the sharp fall in the value of sterling is helping to prop up prices – which presumably also explains why core inflation actually edged up last month, from 1.6% to 1.7%.

However, the flipside is that CPI is now at its lowest level for over a year, and many economists are speculating that it could also lurch into negative territory later this year. Today’s results from Tesco showed that people are taking advantage of lower prices to reduce their bills – and Primark emphasised this, reporting a 5% increase in like-for-like half-year sales this morning. But it looks as though demand remains weak across the board, and if this keeps pushing prices down, the danger is that people will hang on for the lower prices and stop spending altogether.

The Bank of England is clearly worried by this prospect too, judging by the zeal with which it’s embarked on its new quantitative easing programme. As its economists know, when it comes to falling prices, you can have too much of a good thing...

In today's bulletin:
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Deflation fears as retail prices drop for first time since 1960
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