Deflation: It's official (sort of)

February's Retail Prices Index fell to 0%. If prices keep falling, we may be in for a severe case of deflation...

Last Updated: 31 Aug 2010

It's the first time that this key measure of UK inflation has crashed to zero in 49 years. The 0.1% drop from January is caused in the main by the fall in the cost of mortgage repayments. RPI is used as a benchmark for wage deals by the private and public sectors. Many businesses have already instituted pay freezes and it's now looking increasingly likely that the Government might even take in hand promised public sector pay rises. RPI inflation is tipped to remain negative until spring 2010, and could fall to as low as minus 4%, according to the most bearish commentators.

On the other hand, the narrower Consumer Prices Index, which doesn't include mortgage payments and is the inflation measure used by the Government, has risen unexpectedly from 3% to 3.2% - more than one percentage point over Labour's 2% target for inflation. City economists had expected it to drop to 2.6% but instead it has risen for the first time in five months. Mervyn King has blamed the surprising increase on the sharp depreciation in sterling's exchange rate. This all goes to show that not even the most fundamental of macro-economic indicators like inflation is straightforward these days.

But it's not all doom and gloom. Some consumers, dare we say it, might even benefit from a period of deflation. Though our salaries may not have risen as nicely as we might have once expected, paying less for our mortgages frees up readies for discretionary spending. Although the price of food and alcohol has risen, some things, such as clothing, petrol and airline tickets have fallen considerably in the past year.

Deflation may be a good thing for some of us in the short term, but a prolonged bout would do nothing but entrench us further into recession. As The Times writes: ‘Bad deflation sucks the life out of economies.' And like all blood sucking vampires, we need to drive a wooden stake straight through its heart before it gets to our jugular. Merv, it's down to you. 




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