Is the UK in deflation or negative inflation?

Q&A
UK inflation has fallen into negative territory for the first time since
1960, producing quite a few winners and lots of losers Katie Allen
and Patrick Collinson Tuesday 19 May 2015 12.18 BST Queen Elizabeth II visits the then British PM
Harold Macmillan at a ceremony at Oxford
Inflation in Britain has turned negative for the first time in more than university in 1960. Photograph: Terry
half a century, giving a boost to household finances and bolstering Disney/Getty Images
expectations that interest rates will remain at a record low this year.
What does it mean for your finances? And what is negative inflation,
anyway?

What has happened?

The consumer prices index (CPI), a measure of what a basket of goods and services costs, is down 0.1% this April
compared with April 2014. In other words, a basket of goods and services that cost £100.00 in April 2014 would have
cost £99.90 in April 2015.

Statisticians said this was the first time the CPI had fallen since official records began in 1996 and the first time since
1960 based on comparable historical estimates. In March 1960, prices fell by an estimated 0.6% due to commodity
price falls.

The Office for National Statistics (ONS) said inflation in April was pushed down by air fares and ferry tickets, probably
because of the earlier Easter holidays this year. Transport prices rose less between March and April this year,
compared with 2014. Inflation has been slowing throughout most of the last two years on the back of falling food and
energy prices.

I’m confused. Is this deflation or negative inflation?

Economists tend to define a brief dip below zero as “negative inflation”, to distinguish what is likely to be a temporary
spell of falling prices on the back of one-off factors from outright deflation. Having said that, the ONS used the headline
“UK enters deflation” on Tuesday morning.

Economists also look at core inflation, which strips out the more volatile prices such as energy and food to judge
whether we should fear sustained deflation. Core inflation in April was 0.8%, the lowest since March 2001, but still well
above zero. Our economics editor, Larry Elliott, says what we see in the latest figures is not deflation.

Deflation is a generalised and sustained fall in prices, not a brief dip into negative territory on the back of moves in the
oil price or one-off factors such as the timing of Easter, which has played a role in these latest figures. If core inflation
were falling it would be deflation.” Philip Shaw, economist at Investec agrees.

The title of the ONS note ‘UK enters deflation’ released this morning suggests the UK statistics office put today’s
numbers in this category. However, we prefer to classify this as ‘negative inflation’, with deflation more strictly defined
as a period of falling prices that are both sustained and general (i.e. not restrained to one or two sectors). Our own
view is that this negative April print will not turn into a sustained run.”

Economists also talk about different kinds of deflation, good and bad. Similarly, the chancellor, George Osborne, has
warned against panicking over this drop into negative inflation. He said: As the governor of the Bank of England said
only last week, we should not mistake this for damaging deflation.”
What about hidden inflation? I swear chocolate bars are shrinking.

It’s a common feeling. Your favourite chocolate bar seems to be getting smaller. You could have sworn there used to
be more tea bags in a pack. Yet the price is the same as it always was, sometimes it has even gone up.

So is this inflation via the back door? There are indeed plenty of well-known products that have got smaller without
retailers dropping their prices. Retail experts even have a name for this practice of squeezing out the same price for
less: “shrinkflation”. A recent case was the move this Easter to five-packs of Cadbury’s Creme Eggs, downsized from
the old half dozen.

Confectioners are repeat offenders when it comes to this practice but it goes well beyond chocolate bars. Research
carried out for the Observer by the price comparison website mysupermarket.com found across a basket of Christmas
goodies every single item weighed less than it did a year earlier. Annual favourite, a box of Quality Street chocolates,
shed 40g last Christmas to 780g – yet it cost 13p (or 8%) more to buy.

But the ONS points out that this has no effect on the official inflation data. It has almost 300 price collectors in the field
and they check not just prices of items in the inflation basket but also the size and weight. They put this data into
handheld devices and send it off to ONS central office where adjustments are made for size changes.

Where next for inflation?

Economists and the Bank of England forecast that inflation will soon rebound, particularly given oil prices have picked
up from their lows earlier this year. David Kern, chief economist at the British Chambers of Commerce, says:

Despite inflation falling into negative territory, there is no real risk of a prolonged period of deflation in the UK. The
underlying reason for low inflation over the past year has been the dramatic fall in energy prices, however oil prices
have rebounded in recent months, which will put upward pressure on prices ... Our forecast is that CPI inflation will
approach 1.0% by the end of 2015 and reach almost 2.0% by early 2017.”

Does this make me better off?

Yes. Average wage increases are running at about 1.9%, so the fall in prices means the money goes further – largely
because both food and petrol prices have been dropping, although recently the oil price has started climbing again. A
short burst of deflation is a strong stimulant to the economy, as it increases consumer spending power. Car sales in
particular are powering ahead in the UK. But others warn that deflation is a sign that the economy is actually very
fragile. The TUC general secretary, Frances O’Grady, comments: The first period of negative inflation in over half a
century could turn out to be the canary in the mine, signalling that there’s something very wrong with the recovery.”

Who are the winners?

Pensioners and others who have fixed increases should benefit most. The “triple lock” means state pensions rose by
2.5% in April, which means pensioners are enjoying one the biggest real-terms rise in their spending power for years.
The same goes for the 1.4 million workers on the national minimum wage, which is scheduled to rise by 20p an hour to
£6.70, a rise of 3%. The government hailed it as the biggest real-terms rise in seven years – although it doesn’t come
into force until October.

Anyone taking out a new mortgage is also a potential beneficiary. While prices are falling, interest rates will stay at
rockbottom lows. This translates into cheap new fixed-rate deals, with five-year deals now looking particularly
attractive. However, a recent sell-off in government bonds suggests this may not last for long, so it’s a good time to
snap up a deal.

Train fare rises are pegged to a formula of the retail prices index (RPI) +1%, although in recent years the government
has only allowed RPI rises. RPI is still in positive territory – at 0.9% in April. Many rents set by social landlords such as
housing associations are on a CPI+1% basis, but usually based on the CPI figure in September. If negative inflation
continues, rents will therefore only rise by 1% – but they won’t go negative.

Who are the losers?

There are seven times more savers than mortgage holders, and their chances of seeing an early increase in rates are
virtually nil (much like the interest they are earning).

Union wage negotiators will face a tough time arguing for large pay rises. Pay setters in HR departments almost all use
the CPI figure as a starting point, so Tuesday’s figure will be used to beat down pay demands. However, with
unemployment reaching fresh lows, employers may not be able to resist demands.

That said, many employers have already negotiated two- and three-year deals where in year 2 or 3, the rise is related
to CPI – so workers may not get as much as they were anticipating. Many workers at power company EDF, for
example, have their pay set for 2015 and 2016 on a CPI or RPI plus 0.5%, whichever is higher.

Some pensioners will have “index-linked annuities” and will also be worse off, as their income is uprated in line with
CPI or RPI, whichever was used at the outset of their policy.

But in the main this is good news, isn’t it?

Broadly yes, unless negative inflation turns into deflation. That’s when the economists warn of a ‘deflationary spiral’
where consumers put off purchasing, and people in debt see the real value of their debt
escalate ever higher. Think Japan through much of the last two decades. However, few economists seriously believe
we are in for a long spell of deflation, with the oil price having stabilised and begun to turn upwards. Enjoy it while it
lasts.

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