Schroders: UK deflation is temporary

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Azad Zangana, senior European economist and strategist at Schroders is unconcerned by a single negative reading of -0.1% from UK annual consumer price inflation and expects to see higher inflation as 2015 progresses.

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.

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 (causing 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.

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.

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.

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