What is remarkable about this forecast for deflation is that, unlike the US, which just posted flat consumer prices in September, the UK’s recent inflation reports have still been in strong positive territory. Just as its housing market went into a sudden downdraft, Britain’s retail prices are projected to go sharply into reverse.
From the Telegraph:
For the first time since 1960, the cost of living will start to shrink next year, in a worrying parallel of the Japanese “disease” of the 1990s, according to new research.
The news comes amid growing speculation that the Bank of England will soon be forced to cut borrowing costs to 2pc or below, taking them to their lowest level since it was founded in 1694… there is also growing evidence that inflation, which has risen above 5pc in recent months, is set for a dramatic fall. The Retail Price Index – the most comprehensive measure of UK high street prices, will drop at an almost unprecedented rate to -2pc by the second half of next year, according to new research from Fathom Consulting.
It said the fall was largely due to the drop in mortgage costs and house prices, which together form a large part of the RPI. However, lower food and energy prices would also play an important role. Since modern comparable records began in 1956, the RPI has dropped into negative territory only once, in the late 1950s and early 1960s, but it only dropped as far as a rate of -0.5pc.
Andrew Brigden, economist at Fathom Consulting, said: “This does have worrying implications – particularly if it heralded a general period of deflation. The risk is we have a rerun of Japan because you simply can’t [cut interest rates] to below zero.”
Japan suffered almost a decade of deflation and falling economic growth in the 1990s after its debt-fuelled economic bubble burst with painful consequences. Despite cutting official interest rates to zero and pumping cash into the economy, the Bank of Japan was unable to pull prices back up into positive territory for years. However, Fathom predicts RPI will drop below zero for only a few months.
Whereas high inflation tends to encourage borrowing, deflation encourages saving and, as a result, discourages companies from investing and spending today what they could save for tomorrow.
Fathom’s prediction is based on the assumption that the Bank of England cuts interest rates to 2pc within a year. Although markets anticipate borrowing costs falling to only 3.5pc, a growing cohort of economists think it will be forced into taking more drastic action. Mr Brigden said if oil prices came back below $70 a barrel and house prices fall at an even faster rate, the level of RPI inflation could fall as low as -3pc and remain in negative territory for a year.
Although Fathom does not expect the Consumer Price Index – the measure targeted by the Bank’s MPC – to drop into negative territory, Prof Peter Spencer, of the Ernst & Young Item Club, said such an eventuality was not out of the question.
“This time next year we’re looking at all of these huge increases in bills coming out of the index, and then potentially falling,” he said. “CPI will go viciously negative – it’s looking increasingly likely that it drops below target. It could easily go into negative territory, along with RPI.”