15th April 2014
Pressure on the Bank of England to lift interest rates has eased even more as the rate of inflation pulled back for the third month in a row during March writes Philip Scott.
During the month, the cost of living as measured by the Consumer Price Index (CPI) fell to 1.6%, its lowest level since October 2009 and well under the Bank of England’s 2% target. Inflation has now almost halved from a peak of 2.9% last June.
Commenting on the fall, Ben Brettell, economics editor at fund broker, Hargreaves Lansdown says: “Today’s figures confirm the complete absence of pressure on the Bank of England to raise interest rates.
“The Bank of England is now targeting the UK’s ‘output gap’ rather than unemployment. The Office for Budget Responsibility forecast this won’t close until 2018 – combined with continuing low inflation this gives Mark Carney plenty of leeway to keep rates low, and I do not expect them to rise until mid-2015 at the very earliest.”
In addition, the British Retail Consortium’s Shop Price Index showed prices dropped to 1.7% in the year to March – the fastest decline since the index’s inception in 2006 notes Brettell.
He adds: “If anything, deflation could be more of a threat than inflation. There is even an outside chance of further quantitative easing, though this looks unlikely unless we see further sharp falls in inflation over the coming months.”
The latest figure is a small respite for income starved savers, as inflation is eroding their capital at a softer rate than it had been. But equally the lower rate means, a far lower chance of deposit account rates.
Brettell adds: “Lower inflation should be good news for stock market investors, however. Although equities are normally considered the asset class best-equipped to deal with higher inflation, the transition between low and high inflation can be painful for stock markets. A continuation of low interest rates should also be supportive for equities. Falling inflation is also positive for bond investors. Much has been made of the risk that higher interest rates and inflation could cause a sell-off in bonds. Lower rates for longer could postpone this.”
Howard Archer, chief UK and European economist at IHS Insight points out that with headline average earnings growth up 1.7% in January itself, and up to 1.9% in the private sector alone, earnings are now running above inflation for the first time since briefly doing so in early-2010.
He adds: “Clearly below-target inflation facilitates the Bank of England keeping interest rates down at 0.5% where we believe they are highly likely to stay through 2014 and during the early months of 2015 despite the economy’s improved growth and markedly reduced unemployment.
“While encouraged by the economy’s recent stronger performance, the Bank of England is still not taking sustained recovery for granted and very much wants to see growth become more balanced with business investment building on its recent improvement and exports increasingly kicking in.”
Archer’s current view is that the Bank of England will likely start edging interest rates up in the second quarter of 2015 and that they will reach 1% by end-2015 and 2% by end-2016.