Why Record Low Inflation Might Be Good for the U.K.

Weaker than expected U.K. inflation data wasn’t much of a surprise for many, as most forex traders priced in the idea of seeing the headline CPI fall to record lows. In fact, the British pound barely sold off after the release and even managed to advance against the euro and the dollar.

Analysts had already expected the annual inflation reading to have dropped from 1.0% to 0.7% in December but just shrugged off the sharper than expected decline to 0.5%, its lowest reading in nearly 15 years. Apart from the oil price slump, falling prices of supermarket goods were also to blame for the weak CPI figure.uk inflation

With that, BOE Governor Mark Carney would have to write a letter to the Chancellor explaining why CPI is lagging more than 1% below the central bank’s 2% target. This also suggests that BOE rate hike expectations for 2015 can be safely chucked out the window.

While some worry that the U.K. might fall into a deflationary spiral and wind up in a similar mess like that of the euro zone, others believe that the recent downturn in inflation might actually be good for the U.K. economy. After all, lower prices of goods means that consumers have more purchasing power, which might then lift spending and growth later on.

Besides, the U.K. is in much better shape compared to the euro zone, as employment and trade figures have shown sustained improvements. Heck, at this rate, wage growth might actually have a chance at overtaking inflation!

Even the U.K. Chancellor is seeing the silver lining in the latest inflation report, as he mentioned that this could allow family budgets to go further and let more people enjoy the impact of the ongoing economic recovery. In fact, he welcomed the drop in CPI in saying that the U.K. has low inflation for the right reasons.

Whether or not this positive outlook can be sustained in the coming months remains to be seen though, as BOE Governor Carney has projected that further declines in inflation are likely. Do you think this might eventually result to pound weakness?

  • ForExchange

    Hi Forex Gump,

    hmmm that is an interesting perspective (falling inflation helping the UK economy), one that I do not believe in. Deflation is a threat for Eurozone and Japan and they both lose. We can alsways look everything from the bright side but if others lose on weakening CPI, then I do not know why would the UK be different.

    Time will tell.

    Have a nice rest of the week,

    FE

    • Not really a view I also believe in, but it appears that it’s what’s keeping the pound supported for now. I do agree that prolonged weak inflation could be bad in the long run and UK/BOE officials might have to admit this much later on.

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