Heading for 'good' deflation

Falling prices could end up spurring growth in the economy.

The annual rate of consumer price index (CPI) inflation fell to 0.35% in January, from 0.5% the previous month. It is now at its lowest since the official CPI series began in 1997, and was probably last this low in 1960.

The employment rate has climbed back to the record highs of a decade ago: 73.2% of 16 to 64-year-olds are in work. The unemployment rate slid to a six-year low of 5.7%. Average weekly earnings were 2.4% up on last year in December, compared to 1.9% in November. They outstripped inflation for a fourth successive month after lagging it for five years.

What the commentators said

Deflation is often associated with economic troubles: prices fell in the Great Depression of the 1930s and during Japan's ongoing slump, said David Smith in The Sunday Times. If deflation becomes entrenched, it can cause a vicious circle: the real burden of debt rises, causing the private sector to become more and more cautious, further undermining growth and enterprise.

This "bad deflation" does not appear to be a threat, however. We should be in for "good deflation", with falling prices accompanying, and spurring, growth.

There's certainly "no sign of the systemic deflation that took a grip on Japan", added PricewaterhouseCooper's John Hawksworth. Strip out volatile food and energy costs and underlying, or "core", inflation is running at 1.4%, a three-month high.

Retail price index (RPI) inflation, a measure that includes housing costs, is at 1.1%. Domestic demand is solid and should strengthen further: the widening gap between inflation and salary growth should boost consumption, which accounts for most of the economy.

On top of that, there's the benefit of lower oil prices, which, according to Samuel Tombs of Capital Economics, has boosted every household's budget by £350 in the past six months. And consumer confidence is back to pre-recession highs. All this "points to very decent consumer spending figures this year", said ING's James Knightley.

This positive growth outlook, concluded Capital Economics, suggests that the first interest-rate hike could take place late this year.

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