UK falls temporarily into deflation

Deflation hits UK for the first time since 1960

Annual UK consumer price inflation fell to -0.1% in April – the first annual fall in the UK since records began in 1996, and the first time since 1960 based on comparable historic estimates.

Overall, we are not concerned by a single negative reading.

Lower inflation is helping to boost the spending power of households, raising demand in the economy, which should raise inflation rates in time.

In any case, we expect the UK to see higher inflation as we progress through the year and the impact from lower energy prices falls out of the annual comparison.

Bank of England faces interest rate conundrum

For the Bank of England, the challenge is to consider whether the near term disappointments on inflation and the recent GDP growth release outweigh the stronger labour market data seen lately.

If the Bank raises interest rates too quickly, it could scupper the recovery, but if it waits too long, it runs the risk of running higher inflation in coming years.

We expect the Bank to remain cautious, but to consider starting to raise interest rates later this year or early next.

Inflation misses consensus expectations

Consensus expectations were for no change at zero inflation from the previous month, but the downside surprise is largely caused by a significant downward contribution from transport services – in particular air and sea fares, with the timing of Easter this year being later than last, which causes shifts in holiday pricing.

Note, the retail price index (RPI) measure of inflation remained at 0.9%.

UK inflation has been low and falling for some time, largely due to the fall in global oil prices pushing fuel and energy bills lower.

Global agricultural prices have also been falling, helping to lower food price inflation.

However even the core rate of inflation (which excludes the more volatile energy, food, alcohol and tobacco) fell from 1% to 0.8%.

The strength of the pound versus the euro is helping to lower import price inflation and also partly explains recent trends.

The views and opinions contained herein are those of Schroders’ investment teams and/or Economics Group, and do not necessarily represent Schroder Investment Management North America Inc.’s house views. These views are subject to change. This information is intended to be for information purposes only and it is not intended as promotional material in any respect.