Inflation / Deflation

The credit crunch, slow down in the UK economy (and world economy) and fluctuating price of oil is affecting the price of good s and services. In 2008, prices for essential items, such as food, have increased markedly. However, as the price of oil now falls, experts are predicting a decline in the rate of inflation, therefore deflation, and falling prices.

The Office for National Statistics issued inflation figures on the 18th November indicating that inflation is likely to fall sharply in coming months, even falling below the government's 2% target,

Consumer Price Index

The Consumer Price Index (CPI) was recorded as standing at 4.5% in October this year, down from a high of 5.2% in September. For some time now, the Bank of England has said that it expected inflation to peak at around 5% and then start to fall rapidly - this might be the first signs of this happening.

The main reasons for the fall in October is the fall in oil prices, which has started to feed into the index. Petrol prices, for example, fell by 7.1p per litre between September and October, whereas the price had risen by 2.7p per litre in the equivalent period in 2007. The price of food and non-alcoholic beverages also exerted a downward pressure on inflation. Meat prices, in particular, fell compared to a rise in price in 2007; the price of pork and beef were the main contributors. The prices of pre-recorded DVDs, computer games, bank and home delivery charges also had a downward effect on prices.

Retail Price Index

The Retail Price Index (RPI) was also lower - 4.2% compared to 5% in September. Apart from similar factors also affecting the CPI, there were also downward effects from house depreciation, which is not included in the CPI. RPIX, which excludes mortgage interest payments, stood at 4.7% in October, compared to 5.5% in September.

If the Bank of England's forecasts are to be believed, this will be the first of a number of falls in the rate of growth of prices. The real question will be just how far CPI falls below the target level set by the government. This will help to determine future movements in interest rates in the coming months, but the expectation is that there will be further cuts before the end of the year and into 2009 of between 0.5% and 1.5%.

Update: Deflation & Recession (18 December 2008)

The sum of consumer and corporate borrowing in the UK has been estimated at equivalent to 240% of the country's annual economic output. In the US, household and business debt is closer to 300% of that country's GDP.

The alarming and important point to consider, is that if deflation were to set in and prices were to fall, the burden of that debt would increase in real terms, potentially prolonging and exacerbating the severe recessions that appear to be taking hold in both the US and the UK.

Further Information

• Robert Peston's BBC Blog article on Inflation / Deflation