London Briefing: the chill of dipping below zero

If you blinked, you’ll have missed it: the UK’s brief descent into deflation has ended, with official figures yesterday showing the cost of living crept ahead by 0.1 per cent in May.

A month earlier, news that the consumer prices index had fallen to minus 0.1 per cent for April – the first negative figure in more than half a century – sparked frenzied coverage of the dangers of deflation, last seen in Britain in 1960.

The ominous overtones of deflation, raising the spectre of the 1930s’ depression, catapulted the story from the business pages to the front pages. But one month of falling prices does not amount to real deflation, which economists define as a sustained and general fall in prices rather than a brief dip caused by specific factors, such as falling oil prices or the timing of Easter.

It doesn't look quite so dramatic in the headlines but a more accurate description would be negative inflation, which is the term preferred by the Bank of England governor Mark Carney, who correctly predicted that the drop in inflation below zero would be a temporary phenomenon.

There is more than one measure of inflation, of course. While the consumer prices index (CPI) is the government’s preferred measure, there’s also the retail price index (RPI), which includes housing costs. RPI is currently running at 1 per cent.

More important, though, is core inflation, which strips out more volatile items such as energy, food, alcohol and tobacco. Although it came out weaker than economists expected last month, core inflation still rose by 0.9 per cent, against forecasts of 1 per cent, having reached a 14 year low of 0.8 per cent the previous month.

Hyped-up deflation

Behind the increase in May – the first rise since October 2014 – were higher petrol prices, up by 2.5p a litre, and higher air and ferry fares. A slowdown in food price deflation, from minus 1.1 per cent a year ago to minus 0.1 per cent, reflecting the ferocious supermarket price war, also had an impact.

Carney can’t have enjoyed the hyped-up deflation headlines earlier this year. One of the most damaging aspects of true deflation is that it encourages consumers and businesses to delay spending and investment plans in the knowledge that it will all cost less in several months’ time. The saturation coverage of the drop below zero, had it continued, might well have had a subtle psychological effect on consumers, persuading them to reign back spending, with an effect on the economy.

The governor may have to endure another round of deflation headlines in the coming months, however, as it’s possible the reading will dip to zero or below again (April’s negative figure followed two consecutive months at zero). But, again, the descent into “deflation” will be brief, with most economists expecting prices to hover around zero over the summer before rising more decisively in the autumn. It will be some time, though, before inflation gets close to reaching the government’s 2 per cent target, most likely in late 2016 or early 2017.

Any pressure for an interest rate cut now looks to have abated and the general consensus is that the Bank's Monetary Policy Committee will also hold off from raising rates from their current record low of 0.5 per cent for at least another year or year and a half.

For consumers, this period of ultra-low inflation is good news, making their money stretch further after several years of declining household incomes. Chancellor George Osborne, never one to let some good data pass unremarked, yesterday welcomed what he called a "powerful mix" of low prices and rising wages.

Wages rising

There should be further good news on that front today with the latest employment data expected to show that wages are rising at their fastest rate in almost eight years.

Forecasts from the Resolution Foundation think tank predict average weekly wages rose between 2.5 per cent and 2.6 per cent in the three months to April, up from 2.2 per cent in the three months to March. Combined with the 0.1 per cent negative inflation rate in April, that would mean real wages rose by up to 2.7 per cent. Private sector growth is expected to be even stronger, with a rise of at least 3 per cent.

This would be the fastest growth rate since October 2007, and welcome to consumers after the lengthy squeeze on incomes. Yet as inflation starts to climb again, the benefit will increasingly be eroded. The Resolution Foundation says, too, that average earnings remain stubbornly below the level of a decade ago and about £100 a week lower than they might have been in the absence of a downturn.

Fiona Walsh is business editor of theguardian.com