UK set to benefit from first quarter drop in inflation, Item Club says

A rare fall in the cost of living in Britain is forecast for the first quarter of 2015, but any talk of deflation is overdone, according to a highly influential think-tank.

In fact, the UK economy should expand even faster as the collapse in oil prices boosts consumers' spending power and stays the hand of the rate-setters at the Bank of England (BoE), the Ernst&Young Item Club said today in its Winter Forecast.

Nonetheless, there are risks to beware of. Peter Spencer, the chief economic advisor to the Item Club, said: “The global economy has slowed in recent months and question marks remain over the Eurozone, reinforced by worries over the Greek election.”

He added: “Falling oil prices provide a nice offset to the weakness of exports, but will extend our dependence upon the home market and leave the economy seriously unbalanced.”

Inflation is now predicted to fall in the first half of the year and average around zero for 2015 as a whole.

However, as Spencer emphasised in remarks to the Daily Express, that does not constitute deflation. For that to be the case, there would need to be a prolonged drop in prices, which is unlikely.

As a result of lower inflation, Britons will see the income that they can draw on grow by 3.7% this year.

That comes as some observers have drawn comparisons to the highly damaging deflation that was seen in the 1930s. However, GDP is now growing at a nice clip, unlike back then. As research from the Bank of England has pointed out in the past, if policy-makers act quickly and decisively then any deflation should be short-lived.

EY’s new estimate is for growth to power ahead by 2.9% in 2015, up from 2.6% in 2014 and better than the 2.4% that it had previously pencilled in.

Even so, given how unusual falling prices are, one might wonder whether Mark Carney, the Governor of the BoE, has done enough to avoid them.

When questioned on the subject, Spencer said there was “not an awful lot more he can do”, but that Carney could perhaps engineer an additional half point reduction in interest rates.

However, it would not be appropriate, nor is there a need, to do more, the economist concluded.