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Price rises are slowing – but is that good or bad news?

Latest inflation statistics issued yesterday show that the Consumer Prices Index (CPI) fell to 3.0 per cent in January compared with 3.1 per cent in December. This showed that prices were more robust than consensus forecasts of 2.7 per cent had suggested.

 

According to the Office of National Statistics (ONS) this was partly due to the fact that the high street had already slashed prices in December so that the normal effect of the “January sales” did not come through. All in all, there was downward pressure on the CPI from falling transport costs, rents and energy costs but these were more than offset by rises in the price of toys and games, newspapers, books, stationery and holidays abroad. There has been a major impact on import prices from the decline in the value of sterling as the sterling cost of non-oil goods imports rose by 14 per cent in the year to December.

 

The other major measure of inflation, the Retail Prices Index (RPI) actually slowed to 0.1 per cent in January, down from 0.9 per cent in December. This fall was mainly due to the fall in mortgage interest payments and house depreciation, which are not measured in the CPI. Even this was something of a surprise as many thought the RPI would have moved into deflationary territory. The recent picture can be seen below.

 CPI and RPI figures January 2009

 Source: ONS

 

The CPI figure is still above the Bank of England’s target rate of 2.0 per cent but the Bank believes that CPI will fall below target in the coming months and remain there for up to two years. George Buckley, Chief UK Economist at Deutsche Bank, believes that CPI will fall below 1 per cent by the summer.

 

Whilst lower inflation is considered a “good thing” reflecting a falling rate of price increases, deflation is considered a “bad thing” as it would mean that prices are actually falling. With RPI at a 49-year low and about to become negative and CPI forecast to fall sharply the prospect of deflation is now being taken seriously. The problem with deflation is that it kicks off the start of a vicious cycle. As prices start to drop consistently it makes sense for consumer to postpone spending and wait for them to drop further. This means that shops will do less business, and in turn will cut their orders from suppliers, which in turn will see cuts in employment. People who lose their jobs will have less to spend and the cycle becomes intensified.

 

This is what happened in the Great Depression in 1930s America and the world’s economies are struggling to take counter measures. Central banks are slashing interest rates and injecting money into economies at a rate which may well ward off a depression. On the other hand, such actions may be stoking up an inflationary cycle for when the global economy starts to recover.

 

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Posted in Deflation, Inflation

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