Last month UK CPI inflation dipped into deflation territory for the first time since March 1960. Following two months of no inflation (0.0% y/y) in February and March, consumer prices fell marginally by 0.1% y/y in April. Whilst technically this represents deflation, it is not the same phenomenon that blighted the Japanese economy in its lost decades or that occurred during the 1930s depression. In these instances, sustained periods of falling prices were economically damaging as consumers were deterred from purchasing goods as prices would fall in the future.
Last month’s first annual fall in consumer prices in 55 years conceals different price movements between consumer goods and consumer services. Goods prices have fallen by 2% in the 12 months to April whereas the price of consumer services has risen by the same amount. The fall in consumer goods prices is due largely to falling commodity prices, notably food and energy prices. Food prices fell 3% y/y in April while petrol prices were over 12% lower last month than the same period last year. Core CPI inflation – which strips out food and energy prices – eased from 1.0% y/y in March to 0.8% y/y in April. This represented the lowest rate of core inflation since March 2001. We may see another couple of months of ‘deflation’ in the summer.
Thereafter, UK CPI is expected to pick up in the coming months and head towards 2% within the next 2 years. In the meantime, consumers will benefit from the falling cost of living at a time when wages are rising. Household disposable incomes will continue to benefit from this favourable combination. However, all eyes will be on the Chancellor’s Budget on the 8th July. Tax and benefits changes will impact on household disposable incomes too. It should be noted that there are two-year freezes on most benefits due to take place from April 2016. Watch out for more benefit cuts, freezes and tax rises in July.