The inflation rate (as measured by the Consumer Price Index or CPI for all items) has been falling gradually since January 2020 for the United Kingdom.CPI calculates the rise in the price of services and goods in an economy over a stipulated period, usually over the past one year.Looking at the past one-year trend, while the highest monthly figure was seen at 2.1 percent in the months of April and July 2019, the lowest is recorded at 0.8 in April 2020, as per the UK Office of National Statistics (ONS) data. It was reported to be 1.5 percent during March this year. An inflation rate lower than this was seen around four years back in August 2016, when the rate nosedived to 0.6 percent.
Also, it is projected that the inflation rate might slump to zero by this summer.
Monthly trend in inflation rate since January 2019 (CPI Annual, All Items)
(Source: Office of National Statistics, UK)
Why is low inflation an area of concern?
So, should the consumers not start to jump with joy about low prices, now that it means that things are cheaper to their pockets?
The brief response is no!
Keeping the inflation low is but one of the many conflicting macro policy objectives of economic growth. We need to weigh it with other goals, to arrive at a good balance. The other major macro-economic objectives of a nation are economic growth, low unemployment, a healthy balance of payments, low government borrowings, stable exchange rate and equality. Low inflation generally conflicts with economic growth and unemployment.
While low inflation does stabilize the economy and encourage investment to some extent, economists argue that it is not good in the long run, especially if it means that rising unemployment and a drastic fall in demand are its root causes, which is the case today. Unemployment has a huge social cost, more than that of rising prices, and we do understand that. The number of people claiming jobless benefits has risen sharply to 2.1 million in April 2020, up by 70 percent from a month ago.
Low prices may also signal an economic recession. Such a scenario is actually visible in this corona pandemic time, where the economy has been badly disrupted, and work is practically halted across a majority of goods and services. It also pushes up the value of debt, be it of the government or the industry. The BANK of England expects the UK economy to shrink by 14 percent for the year 2020.
In fact, some economists do believe that a gradually rising inflation rate actually leads to good and sustainable GDP growth in the economy.
Reasons for the falling prices
The current trigger in falling prices is coming from the steep fall in the price of petrol and diesel, since the past 2 months. Vexed by a mismatch in global demand and supply, the petrol prices fell drastically by more than 10p between March and April 2020 in the UK and are hovering below one pound per litre. This is the largest monthly fall ever witnessed, since the year 1990. The low inflation is also driven by a crash in energy and water bills. Though, the prices of online toys and games have risen, along with that of knitting wool, since people have more free time and are home-bound, more so after the corona induced lockdown. The price of fruits and vegetables has also shot up slightly.
People are being laid off across sectors and locations in Britain. This has led to a pulling back of the demand for all goods and services, which has, in turn, put a downward pressure of prices for all items.
Contributions to change in the CPIH 12-month inflation rate between March and April 2020
(CPIH-CPI including owner occupiers’ housing costs)
(Source: Office of National Statistics, UK)
The break-up of the category wise contribution to inflation rate table above also reveals that falling housing, household and transport services (includes the impact of fuel prices) have contributed heavily to the low inflation late between March to April 2020.
The largest fall was seen in the category of housing and household services (it includes utility bills). The monthly contribution of this category to inflation reduced by 0.35 percentage points in April 2020.
The second biggest contributor was transport, whose share lowered by 0.27 percentage points for the same month. Apart from crashing crude oil prices, another cause for this category’s falling share is the reduction in transport services, with travel restrictions in place across the nation.
Clothing and footwear category declined by 0.08 percent.
Across all the categories listed, in fact, a marginal rise in inflation is seen only in food, alcohol and recreation (which includes online games and hobbies).
Restaurants and hotels saw an upswing of 0.03 percent due to the crawling of fast food and takeaway deliveries.
The Bank of England’s inflation target is set at 2 percent, to attain its particular macro-economic objectives. In case this rate is missed by more than one percent on either side (high or low), the governor has to explain the reasons to the Chancellor. While we wait to see what’s written in the letter by BoE governor Andrew Bailey to Chancellor Sunak, it’s very much clear that coming out of this economic mess is not going to be that easy and the UK Government will have to jump through hoops to get back in shape.
With Bank of England reducing the interest rates to a historic low level, the spotlight is back on diverse investment opportunities.
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