The UK could experience negative inflation this spring, warns Bank of England Governor Mark Carney, but he says, if needed, the bank is prepared to cut interest rates to prevent long-term deflation.
However Mr Carney insisted there is no threat of persistent deflation in the UK.
The Bank of England is prepared to lower interest rates below its current 0.5 per cent base rate if inflation remained persistently below target, Mr Carney said, though he added his “central expectation” was that a rate rise would be the Bank’s next move.
His comments appear to be preparing the country for the likelihood of negative inflation while stressing it would be a temporary phase in a wider return to growth.
“We’re going to have a period where headline inflation is low – very low – for most of this year, and that’s a good thing in general because of the causes of it. It’s not a good thing if it persists though,” Mr Carney said.
Latest projections in the Bank’s quarterly inflation report suggest that the Consumer Price Index (CPI) will average at around zero in the second and third quarters this year before starting to climb towards the end of 2015.
An inflation rate below 0 per cent will raise fears of the UK veering uncomfortably close to the scenario playing out in the eurozone, where there are fears of a damaging deflationary spiral after inflation fell to minus 0.2 per cent.
Hence Mr Carney used this morning to explain how negative inflation – if and when it hit – would be temporary and that numerous emergency measures are in the event of it.
As well as an interest rate cut, the Bank of England is prepared to add to its £375bn quantitative easing programme should it need to.
What is deflation? Economics Editor Paul Mason explains: Deflation does not only mean the value of everything gets smaller. It means that people become less and less able to pay off their debts - as the debts do not deflate in line with incomes and interest rates.
He said that inflation would rise quickly at the end of this year and that markets had recently got ahead of themselves in expecting no interest rate rises until late 2016.
He conceded that an acrimonious Greek exit from the Eurozone would change the UK’s outlook, though he said the impact would not be as heavy as it would have been three years ago.
He said: “Would a change in Greece’s position have an impact on the forecast? Yes.
“Would it have the same impact on the UK economy as it would have had on 2012? No.
“There are differences now than there were in 2012.”