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07:12 GMT, February 8, 2015Bank of England’s Governor Mark Carney is to dramatically cut the UK central bank’s inflation forecast to very close to zero when his updated outlook for the country’s economy is published on Thursday.
Mr. Carney had already warned that there was a likelihood the CPI (Consumer Price Index), which measures the changing price levels of consumer goods and services bought by households, could decline during the next few months.
Annual inflation in the UK declined to 0.5% in December from November’s 1%. December’s figure was the equal-lowest on record.
When annual inflation veers too far from the Bank of England’s 2% target, Mr. Carney has to write a letter to Chancellor George Osborne explaining why, and what the BoE plans to do about it.
Mr. Carney will have to explain to the Chancellor why annual inflation has drifted too far from the BoE’s 2% target.
Britain’s falling inflation rate has been mainly caused by the price of crude oil plunging by over 60% since peaking in June 2014, and a fierce supermarket war that has driven down food prices.
This is the first time Mr. Carney, who became Governor in July 2013, has had to explain to the Chancellor in writing. His letter will accompany the BoE’s quarterly inflation Report on Thursday, February 12th.
The Belfast Telegraph quoted HSBC’s chief UK economist, who said “(the BoE’s new report) may be the first to show a central projection for inflation that is, in some quarters, negative. It could be the BoE’s first deflation report.”
Interest rate hike in 2015 unlikely
The BoE has kept the benchmark interest rate at 0.5% for six years. Not that many months ago analysts were betting on a rate hike in the middle of 2015. Since the CPI started to fall, these forecasts have disappeared and now most people doubt the central bank will consider raising rates any time this year.
The BoE’s Monetary Policy Committee (MPC), which meets every month and decides whether interest rates should go up, down or stay unchanged, voted unanimously last month to keep them at 0.5%. It was the first time in six months that all nine MPC members voted in the same way.
From August to December, the two MPC ‘hawks’, Ian McCafferty and Martin Weale, had voted to raise rates. After inflation fell to 0.5% in December they fell into line with the others.
Will wages push up inflation?
While predicting that inflation may fall further, Mr. Carney also warned investors in January that record-low interest rates may not last as long as people expect. In Davos, Switzerland, he said the BoE was monitoring wage hikes closely.
Wages in Britain have failed to keep up with inflation for several years. Recently, however, pay has started to accelerate.
Economists believe that 2015 will be the year in which wages will make up for years of stagnation.
Mr. Carney said (in Davos in January) “One word on the UK – is that we have a very low inflation environment right now largely caused by commodity prices and an ability to look through that.”
When inflation falls too low, or goes into negative numbers (deflation), economists say there is a risk the country may fall into a spiral of falling prices and no economic growth (stagflation). Consumers postpone their purchases because they prefer to wait for better deals later, this leads to falling sales, lower profits, and eventually job losses, falling wages and a shrinking economy.