UK Low Inflation Could Turn into Deflation

Gentle inflation is a spur to spend – because if you’ve got the money and you’re not feeling gloomy, then you will spend today, because tomorrow prices might be a bit higher.

It is also a spur to borrow for investment, in a home if you are a household or in productive kit if you are a business, because if you think your earnings will at least rise in line with inflation, then the burden of your debt will diminish with passing years.

So moderate inflation tends to be associated with steady growth in national income – of the sort that should make us sustainably richer

That is why the government has set a target for the Bank of England of setting monetary conditions – through changes to the interest rate for lending to banks and via quantitative easing – to keep inflation at 2%, with a one percentage point margin of error on either side of 2%.

So with CPI inflation today announced at 0.5% for December – the joint lowest since records began in 1989 – the Bank of England has failed.

And for the first time ever it has failed because inflation is too low (it missed the target on the upside well over 30 times after 2007).

Now as I said yesterday, that failure is – arguably – good news, at least in the short term.

That is because what has been driving inflation lower has been a 10.5% fall in motor fuels over the past year and a 1.9% fall in food prices. And since we have to buy food and fuel, those reductions increase our spending power, they make our money go further – they are the equivalent of a lovely hefty tax cut (of the kind that the chancellor would love to give us but can’t afford).

via BBC

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Alfonso Esparza

Alfonso Esparza

Senior Currency Analyst at Market Pulse
Alfonso Esparza specializes in macro forex strategies for North American and major currency pairs. Upon joining OANDA in 2007, Alfonso Esparza established the MarketPulseFX blog and he has since written extensively about central banks and global economic and political trends. Alfonso has also worked as a professional currency trader focused on North America and emerging markets. He has been published by The MarketWatch, Reuters, the Wall Street Journal and The Globe and Mail, and he also appears regularly as a guest commentator on networks including Bloomberg and BNN. He holds a finance degree from the Monterrey Institute of Technology and Higher Education (ITESM) and an MBA with a specialization on financial engineering and marketing from the University of Toronto.
Alfonso Esparza