Deflation could be just around the corner, warns Carney

And he’s not ruling out more quantitative easing or even a further cut to interest rates

Most of us wouldn’t mind a drop in the prices of the things we buy day-to-day.

As it is, the average prices of consumer items have been increasing at a particularly slow rate: inflation is at an all-time low of 0.5% (since records began two decades ago), and it’s been that way since December.

At the start of this year, a fair few economists said we could in fact be on the brink of deflation, i.e. seeing a drop in average consumer prices.

Now the governor of the Bank of England, Mark Carney, is warning that deflation could come as soon as this spring.

He writes in his opening remarks to the Bank’s inflation report, which came out late yesterday: “[Inflation] will likely fall further, potentially turn negative in the spring, and be close to zero for the remainder of the year.”

That’s because of the steep drops in oil and food prices we’ve seen globally of late – with oil prices in particular having a widespread knock-on effect on all types of industries and products, as it’s used in so many materials as well as for energy.

But Carney knows that us Brits love a bargain. He acknowledges that the effect of low inflation and possible deflation on consumer prices is “generally good news for British households”.

It’s not just oil and food prices causing this low inflation though.

Carney writes: “Commodity prices do not, however, wholly explain why inflation is so low. The balance of the gap from [the 2% inflation] target is the result of subdued generalised inflationary pressures. Core inflation is running at around 1.3%. This reflects a long period in which unemployment has been high and wage growth muted as well as the remaining degree of slack in the economy, currently judged to be in the region of ½ per cent.”

So what will the Bank’s Monetary Policy Committee (MPC), whose remit it is to keep inflation at the chancellor’s 2% target, do about it?

Well, the committee has a range of tools at its disposal for trying to keep inflation on target.

Carney says in his notes that we could see an increase – or even a further cut – to the Bank’s base rate of 0.5%, which has been at its historic half-percent low for six years now.

If certain economic risks come to pass, the Bank could also expand the Asset Purchase Facility – i.e. increase quantitative easing.

“Whatever transpires, the Bank has the means, the will and the responsibility to set monetary policy to achieve the target over an appropriate horizon,” Carney writes.

But the MPC is not in any hurry, as it is well aware that our economy is still fragile – even though Carney is more bullish about economic growth now than he was in November.

So it’s aiming to bring inflation back to the 2% mark within the next two years.

“British workers and employers can count on that as they make important decisions about wages, hiring and investment,” he adds.

And the likelihood is that we will see “limited and gradual [Bank interest] rate increases” as the primary tool for bringing inflation back to target, which is what is widely expected.

As Carney acknowledges, these rather undramatic increases “may not make the headlines, but they will likely be consistent with the continued normalisation of the UK economy and with meeting the 2% inflation target”.

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