Deflation hits Britain for first time in half a century

Published on Tuesday 21 April 2009 22:08

THE cost of living in Britain has fallen into negative terrority for the first time in almost half a century.

The Retail Price Index (RPI) dropped to minus 0.4 per cent in March, according to the Office of National Statistics (ONS) – the first time the UK economy has experienced deflation since March 1960.

The development had been widely expected and has been predicted by the Confederation of British Industry (CBI) to continue throughout the year before picking up again in 2010.

But there were concerns from trade unions that it will have an impact on pay, while pensioner groups warned it could lead to them losing out as pensions are linked to the RPI.

There were further fears that the news could herald a period of stagnation similar to that which has blighted the Japanese economy for two decades.

The official Consumer Prices Index, a measure of inflation which excludes mortgage payments, also dropped last month, from 3.2 per cent in February to 2.9 per cent. But it is still well above the government's 2 per cent target.

Union leaders warned employers they should not use deflation as an excuse to implement salary freezes or pay cuts.

Brendan Barber, the TUC general-secretary, said: "Although in some workplaces unions have agreed to put pay increases on hold or take cuts in wages to save jobs, many companies are still profitable and able to afford decent pay rises.

"Widespread wage freezes would prompt families to cut back on their spending, which would be the last thing the UK's struggling economy needs right now."

However, the news did not cause immediate concern for business leaders in Scotland.

Iain McMillan, the director of CBI Scotland, said: "The drop has not come as a surprise and we have predicted that, on balance, RPI will fall by 0.9 per cent in 2009 before picking up to positive inflation of 2.6 per cent in 2010."

He added that the worst period of deflation was expected to be in September. However, the government will still raise pensions based on the RPI rate.

There were also warnings that pensioners are still facing inflationary pressures. The latest figures from Alliance Trust Research Centre showed that the inflation rate faced by the over-75s was 4.6 per cent in March, a massive 59 per cent higher than the official rate of inflation of 2.9 per cent.

Michelle Mitchell, charity director of Help the Aged and Age Concern, said: "Falling headline inflation masks the fact that many older people's real rate of inflation remains far higher than the average."

A fall in energy and food costs led to the deflation – gas bills and the cost of heating-oil both dropped – and prices of food and non-alcoholic drinks also slid, the ONS said.

Short-term boost must be weighed with risks

IN NORMAL circumstances a small level of inflation allows for growth in the economy and standards of living.

The fear is that inflation will go too high leading to a devaluation of savings, wages and products. Bank of England policy has for a long time been directed at keeping inflation down.

Deflation is a rare situation for an economy to be in, but in the short term it can be good news for some and stimulate a boost to the economy.

However, as experience in Japan has shown, a sustained period of deflation leads to stagnation in the economy with consumers no longer buying and a corresponding drop in the production of goods and jobs. It can drive down wages and lower the standard of living.

In the immediate future though consumers should benefit from a fall in the Retail Price Index (RPI), simply because items in the shops will be cheaper.

This is particularly true for those who have already secured pay rises. However, for those who have not yet got a pay rise, deflation could lead to a freeze in salaries or even cuts.

In September there is also a concern that deflation will be at its worst which is likely to have an impact on state pensions that are now linked to the RPI.

It is also bad news for people who owe money, because deflation intensifies debt which does not drop. People with RPI linked mortgages will also find their payments cannot drop any further.