What does deflation mean for homeowners, SMEs and savers?

POSTED: 26th March 2015
IN: General

With inflation falling to its lowest rate since records began, should businesses, savers and homeowners be concerned about the prospect of deflation?

undefinedAfter several successive month-on-month falls, inflation fell to 0.0 per cent in February, according to the Bank of England, representing the lowest recorded rate since the Bank began registering comparable statistics in 1989. This led to suggestions that the UK could soon enter into a period of deflation, but what would falling prices mean for British companies and consumers?

Analysts argue that in the short-term, deflation can bring many significant benefits, as falling prices mean purchasing power improves for both savers and businesses, who will see their money stretch further. In particular, since the lower rate of inflation has been largely fuelled by a rapid decrease in oil prices and competition between supermarkets driving food prices lower, families will be spending less on basic living costs.

However, Bank of England Governor Mark Carney has admitted these positive circumstances could turn into a more worrying trend if prices fall for an extended period of time.

“We're going to have a period where headline inflation is low - very low - for most of this year, and that's a good thing in general because of the causes of it,” stated Carney, adding, “It's not a good thing if it persists though.”

In principle, the main risk of deflation is that both businesses and consumers may put off purchases, believing they will get a better deal in the near future as prices continue to fall. If many people behave in this way, it can lead to a fall in demand and firms may scale back production, which in turn can push up unemployment, causing demand to fall further as the economy enters into a downward spiral.

The fact that business investment fell by 1.4 per cent in the final quarter of 2014 has added to fears that the UK could be in danger of approaching this scenario. This has been compounded by figures from the Institute of Fiscal Studies, showing that consumption rates for non-durable goods have failed to regain pre-recession levels, even though this ground was rapidly recovered in previous economic recoveries.

Equally, the current strength of the pound against other global currencies may be having a negative effect on UK exports, since British goods become relatively expensive for foreign buyers to purchase, as Carney confirms:

“The bottom line is that there is a risk that the combination of persistently low global inflation and the strength of sterling could weigh on prices here for some time.”

Fortunately, several factors also suggest inflation could begin to climb again later in 2015, particularly as unemployment has dropped to just 5.6 per cent, restricting the availability of new employees and putting upward pressure on wages. In fact, Ernst and Young’s ITEM Club has already predicted wages could increase by 1.9 per cent in 2015, leading Bank of England Monetary Policy Member Martin Weale to comment:

“If wage growth continues to accelerate over the next few months, especially in the absence of a pick-up in productivity, then for me it strengthens the case for a rise in Bank Rate.”

Take a look at this helpful video guide from the Telegraph for further advice on the impact of deflation.

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