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Time to celebrate zero inflation?

It sounds like a good reason to celebrate that the Consumer Prices Index (CPI) inflation measure has dropped to zero for the first time.

The Office for National Statistics (ONS) said its headline CPI measure of inflation eased from 0.3% in January to 0% in February year-on-year. This is the lowest since the records began.

To those of us that are looking to spend more, this is good news as more can be bought with your money. Hopefully this will provide a further boost to the economy by encouraging people to dip into their pockets more.

Considering the flip side, if consumers and businesses expect prices to start to fall, then they might put off spending and investment. What’s more, if the Bank of England expected inflation to be low for a protracted period of time then they might cut interest rates even further to get inflation up to the 2% target. This would be bad news for savers.

It is important to remember that CPI measures inflation by taking a basket of goods – food, clothes, petrol etc - looking at what they cost last year, looking at what they cost now, and finding the proportional difference.

But unlike the more traditional measure of inflation, the Retail Prices Index, CPI leaves the costs of buying and maintaining your home out of the basket – so rises in things such as mortgage payments and council tax, which in real life you pay, don’t get reflected in it. RPI does take account of those costs, and it still stood at 1% in February.

In real life, it is not just about the increase in the price of a basket of goods, but this along with the rise in wages as well. Average weekly earnings grew by 1.8% over the twelve months to January.

If your income is keeping pace with headline inflation but not average weekly earnings then, over time, your quality of life could gradually decline relative to everyone else.

The recent falls in inflation could be short term, as they are mainly caused by a deep oil price slump and a fierce price war being fought out by supermarkets. Core CPI, which measures inflation with the more volatile aspects such as energy and food taken out of the basket, was at 1.2% in February.

With the oil price now seeming to have stabilised at a new lower level, the drop in inflation rates caused by its fall will likely wash out at the end of the year, and rates will normalise again. Plus, any increase in the oil price will in fact push up inflation.

The danger is current low rates may lull people into a false sense of security, and if they don’t invest to ultimately combat the erosive effect of inflation, they could suffer in the long run.

This was posted in Bdaily's Members' News section by Lowes Financial Management .