Cost of living turns negative

21 April 2009

The cost of living is set to fall to levels not seen since 1949 with one measure of inflation creeping into negative territory in March.

Official figures show annual inflation, as measured by the Retail Prices Index (RPI), went negative in March for the first time since 1960. It is now -0.4%, down from 0% in February.

The Consumer Prices Index (CPI) – the official measure of inflation that, unlike the RPI, does not include mortgage interest payments – fell to 2.9% in March, down from 3.2% in February and 3% in January.

The figures are largely in line with inflationary expectations, with the recession bringing the cost of living down. However, there are concerns the CPI is falling at a slower pace than anticipated.

Jonathan Loynes, chief European economist at Capital Economics, says that although CPI decreased last month, on the back of lower food and energy costs, the VAT cut last December has slowed its fall.

But he adds: “There are good reasons not to get too worried. For a start, energy prices should fall a fair bit further over the coming months. There are also some signs that food prices might have started to drop. And second, we suspect that the weakness of retail spending and activity in general will bear down strongly on core inflation in time.”

With these factors likely to keep inflation moving on a downward path, the threat of a longer period of deflation still looms.

“UK inflation is still set to drop a lot further and the threat of a broader bout of deflation has not evaporated,” warns Loynes.

The Bank of England’s base rate cuts have brought the RPI into negative territory, with mortgage interest payments down by 42.2% year-on-year.

Charles Davis, economist at the Centre for Economic Business Research, explains: “This – and particularly food and fuel costs – drove inflation on the PRI into negative territory. Inflation on this wider measure is likely to reach its lowest level since monthly data began in 1949 in the coming months.”

Davis believes the CPI will also turn negative later this year.

Given that RPI is used as a benchmark by many trade unions and organisations to gauge wage increases, experts forecast many employees could endure pay freezes - and even pay cuts - this year.
Pensioners are also likely to be affected by deflation, if it continues for the rest of the year, as the government uses September's RPI as a measure for annual rises in the state pension and other benefits.

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