A decrease was predicted, but the year-on-year decline was slightly more than forecast, lending credence to expectations the country could head into deflation territory in the next few months. It also underlined the conundrum facing the Bank of England as to what to do with rates.
According to the ONS, the decline was led by fuel and food, prices of which have now fallen or remained unchanged for 18 and 10 months respectively. But, it added, the further decline seen between January and February came on the back of price movements for “a range of recreational goods (particularly data processing equipment, books and games, toys and hobbies), food and furniture and furnishings.”
Core inflation which excludes both food and fuel, remained more stable at 1.2%.
Heading toward deflation
And, the expectation is that this downward trend is likely to continue, toward deflation. As revealed in the minutes of the latest meeting of the Bank of England’s monetary policy committee, the Bank’s central expectation “was for CPI inflation to fall to around zero in the February data and remain at around that rate for several months.”
“Given the inevitable uncertainty surrounding that central estimate, it seemed more likely than not that CPI inflation would temporarily drop below zero at some point over the coming months,” it added.
But, while further declines might be expected, the MPC’s central case is that this effect is only temporary, coming largely on the back of a combination of higher sterling and the “unusually weak contributions from energy and food prices”. As such, the MPC members expect these impacts to fall away over the course of the year.
However, it was careful to note: “These factors were not the only causes of inflation being below the target, however: the weakness of domestic cost growth had also played a role. A central question, therefore, remained whether pay growth, and so domestic cost pressures, would pick up to a rate consistent with meeting the inflation target in the medium term.”
For Charlotte Morrish, a member of Schroders’ business cycle team: “Prices in a number of consumer services segments, such as restaurants & hotels and education increased at similar rates to a year ago, suggesting that consumer demand in the UK remains stable.
“Meanwhile producer prices showed substantial declines in input prices (-13.5%) and more mild disinflation in output prices (-1.8%), which should serve to support company margins as well as the outlook for the labour market. House price inflation remained robust at +8.4%,” she added.
As a result of these numbers, and the view that the decline in oil prices is the result of oversupply, rather than weak demand, a view the BoE also holds, Morris said the lower inflation that has resulted will serve to prolong the UK business cycle.
“If end demand remains positive, then falling prices should not feed through into wage negotiations and the current low rate of inflation is, therefore, likely to be temporary. In the short-term this means that the UK’s interest rate trajectory is more likely to be driven by labour market data than movements in the headline inflation rate.”
The opposing view
Ben Brettell, senior economist at Hargreaves Lansdown is less certain, however, pointing out that the MPC minutes quoted above raise a flag, albeit a small one, about domestic growth concerns, and “cast doubts over whether wages are rising quickly enough to return inflation to target”.
Brettell adds that it is these doubts that prompted the Bank’s chief economist, Andy Haldane to warn that his fellow policymakers “may be underestimating the risk of deflation,” he added.
Haldane, in a speech last week, and careful to highlight that he spoke in his personal capacity and not on behalf of the MPC, made the case that as much as a third of the fall in UK inflation is not explained by weak external prices and, thus, there remains uncertainty as to the persistency of the current disinflationary trend.
In his conclusion, he said: “I do not currently see an immediate case for a policy change in either direction. If one were required, given the asymmetry of inflation risks, I think the chances of a rate rise or cut are broadly evenly balanced. In other words, my view would be that policy may need to move off either foot in the immediate period ahead, depending on which way risks break.
Such statements raise the question of exactly how unanimous the MPC remains over where inflation is likely to go and how long it will stay there. And, importantly for investors, add to the likelihood that a rate hike in the UK remains a way away.
As Brettell said, while, a cut in interest rates looks most unlikely: “with inflation at zero and deflation looming it is almost impossible to see them rising either. It therefore appears interest rates will be stuck at 0.5% for some time yet – I don’t see them rising until mid-2016 at the very earliest.”
