POLITICS

Deflation Fears Played Down By Mark Carney And George Osborne

14/01/2015 09:45 GMT | Updated 14/01/2015 12:59 GMT

Mark Carney and George Osborne have tried to calm fears that Britain's economy could fall into a damaging deflationary spiral after new figures showed that inflation had dipped to a 15-year low.

The Chancellor will say the recent slump in the headline Consumer Prices Index (CPI) inflation rate to just 0.5% is due "mainly to external factors", and should be viewed as "welcome news for Britain's households".

However, some economists fear that Britain's fall in prices could hold back the economy by discouraging consumers from spending as they would expect prices to fall still further, which would pile pressure on businesses and wages.

Such a scenario would bring Britain close to what is seen in the Eurozone, where the European Central Bank has been forced to bring in negative interest rates and consider quantitative easing in order to revive the moribund economy.

Ann Pettifor, director of Prime Economics, has warned that Britain will "likely experience deflation" this year, and that the Bank of England may struggle to deal with it.

She wrote: "It is doubtful whether central banks and finance ministries have sufficient policy tools to arrest a generalised, downward spiral of prices, which will lead to declines in profits, further falls in real wages, rising unemployment and ever-sharper falls in prices. Which is why deflation is such a terrifying prospect."

The Bank governor has admitted, in an interview with ITV News, that deflation was "possible", but insisted policymakers could take action to fix it.

"The good news is that we have the means and the will and the responsibility to get inflation back up over the medium term within two years lets say to that 2% inflation target and we will do that," he said.

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However, on Tuesday it emerged that he will suffer the embarrassment of having to write to Osborne to explain why inflation has fallen so far away from the Bank's 2% target.

Osborne, meanwhile, in a speech to the Royal Economic Society on Wednesday, will say: "The low inflation we see here in the UK - driven as it is almost entirely by external factors such as the oil price - is much more welcome than in the eurozone where inflation has been very low for some time and is now negative.

"There the debate has understandably turned to the dangers of deflation - the risk of a self-reinforcing spiral where economic activity falters, consumers defer purchases as prices fall and nominal debt burdens become ever harder to manage."

"Of course we will always remain vigilant to ensure that inflation is low for the right reasons. But we should not confuse this welcome news for Britain's households as a result of falling oil prices with the threat of damaging deflation that we see in the eurozone.

"Rising real incomes, a recovery spreading to all parts of our economy, and family budgets that can stretch that little bit further - let's celebrate these effects of low inflation, not fear them."

Other economists have endorsed Osborne's optimism. Samuel Tombs, senior UK economist at Capital Economics, told the Huffington Post UK that he expected Britain to experience deflation "in the next couple of months" for a "short-lived period".

Victor Golovtchenko, an analyst at Forex Magnates, said: "The disinflation which we are currently seeing in the UK is healthy to the economy rather than worrying.

"In fact, lower prices is exactly what the UK consumer needs, and a sobering experience for all the economic pundits that claim that somehow higher inflation equals higher growth numbers."