Inflation forecast "close to zero"

Thursday 12 February 2015

The Bank of England looks set to cut its forecast for inflation close to zero when it publishes its latest outlook for the economy today.

Governor Mark Carney has already acknowledged there is a strong chance that the Consumer Price Index (CPI) measure of inflation will turn negative this year.

The Bank's projections in its quarterly Inflation Report will update previous figures in November, since when CPI has fallen more steeply than expected.

Latest figures showed CPI dropped to 0.5% in December, equalling its lowest level on record, and meaning Mr Carney must write a letter to the Chancellor to explain why it is more than 1% off its 2% target. It has been driven down by tumbling oil prices, lowering the cost of petrol, as well as the supermarket price war amid fierce competition in the sector.

The letter, the first Mr Carney has been obliged to write since he took the helm at Threadneedle Street in the summer of 2013, is due to be published alongside the Inflation Report.

Simon Wells, chief UK economist at HSBC, said the Bank's new report "may be the first to show a central projection for inflation that is, in some quarters, negative".

"It could be the BoE's first deflation report," he added.

Mr Wells pointed out that since the Bank's prediction last month of a "roughly even" chance of negative inflation, there had been further downward pressure on the CPI forecast as household energy tariffs were cut. He said the Bank might make its first ever forecast of "outright deflation", for the second quarter of this year.

Analysts will study the report and Mr Carney's remarks at a press conference for clues about when the Bank's Monetary Policy Committee (MPC) may act to hike interest rates above 0.5%, where they have been held for six years.

An ultra-low path for inflation could cement expectations that rates will not rise until well into next year, but there will also be a focus on how much emphasis the MPC chooses to put on other factors such as improving economic growth and wages.

Signs that it is placing greater importance on these factors - and will "look through" temporary effects driving the present CPI level - could be taken as a "hawkish" sign that there remains a slim chance of an interest rate hike this year.

Low inflation has removed pressure for an increase, with even the MPC's two "hawks" reversing their calls for a rise last month.

Mr Carney has said that the fall in inflation is "good news in the short term" for UK households as it boosts spending power. But he acknowledged the dangers that could be posed by it turning negative.

The fear from deflation is that it could result in a damaging downward spiral as households postpone spending and firms delay investment as they expect prices to fall.

Markets have pushed back expectations of an interest rate hike because of the Bank's obligation to bring CPI back up to a more normal level.

Jitters over the eurozone - as the Greek debt crisis resurfaces - and the UK general election also seem to boost arguments to leave rates low in order to keep the economic recovery on track. But fears of a slowdown in the UK economy - after growth slowed more sharply than expected to 0.5% in the fourth quarter - have been partly allayed by latest economic surveys pointing to a healthy start to 2015.

The fall in the oil price is itself seen as providing a major stimulus to the economy as it feeds through to a boost in spending power.

Kathleen Brooks, a research director at Forex.com, said: "Growth could be the bright spot of the report, and there is a chance that the Bank's growth expectations could be revised higher."

She said an emphasis on wage pressures and stronger growth could see the pound rise.