Deflation hits economy for first time in 50 years

On the eve of Alistair Darling's Budget, the British economy has entered a period of deflation for the first time in 50 years. The retail prices index (RPI), which includes among other things mortgage repayments, which have plummeted because of the fall in interest rates, fell below zero in March - to minus 0.4 to be precise - for the first time since 1960.
 
The fall in the RPI sparks fears that private sector wages and state pensions, for which rates are often calculated based on the measure, could be reduced. Worse still, there have been predictions that the RPI will continue to slide and that the consumer prices index (CPI), which excludes mortgages, could follow suit. The CPI, the figure that politicians, rather than statisticians and employers, use to measure inflation, has also slipped: down from 3.2 per cent to 2.9 per cent, which is still above the government's target of two per cent.
 
Among other factors, the drop in prices has been attributed to the falling cost of fuel, which forces air fares lower, and the revival of Spanish vegetable imports, which forces UK food prices down. The fall in RPI is not necessarily bad news though. With prices down, some experts hope the economy will receive a boost as consumers find their spending power increased. Rail fares could also fall if RPI goes below minus one per cent by July, when prices would usually be raised by one per cent above RPI.
 
The major disadvantages of deflation are for companies selling goods or services which become less profitable and so lead to a reduction in earnings and knock-on job losses. There are also fears that consumers could hold on to their money, expecting prices to fall further, and therefore slow down the economy.

Furthermore, for debtors, including the government, a fall in RPI means a rise in the value of the pound and therefore an increased amount to pay back in real terms. And pensioners with index-linked pensions are likely to see their payments fall.

It is these effects that have led economists to point out that it was deflation that led to the beginning of Japan's 'lost decade' at the beginning of the 1990s.
 
WHAT THEY ARE SAYINGBrendan Barber, TUC general secretary, on the BBC: Although in some workplaces unions have agreed to put pay increases on hold or take cuts in wages to save jobs, many companies are still profitable and able to afford decent pay rises. Widespread wage freezes would prompt families to cut back on their spending, which would be the last thing the UK's struggling economy needs right now.

Vince Cable, Lib Dem Treasury spokesman, in the Guardian: A gaping chasm is fast developing in the way inflation affects the rich and poor. While those on higher incomes who have seen their mortgage costs plummet are now experiencing deflation, those on lower incomes whose money goes on basics like food and clothes are still seeing their costs rise. With lending rates at a record low, the Bank of England finds itself in the unenviable position of fighting both deflation and inflation.

Howard Archer, economist at HIS Global Insight, in the Guardian: The inflation data do little to dispel expectations that interest rates are set to stay at 0.5 per cent for an extended period and that the Bank of England could eventually extend its quantitative easing programme. The danger of an extended, deep recession still outweighs inflation risks.

Robert Cole in the Times: Governments hate deflation because they are habitual borrowers, and the last thing they want to do is spend a larger part of their declining tax revenues on paying interest. Those with mortgages should be similarly fearful. However, although inflation is disliked, it is seen as the better of two evils - not least because inflation lightens the underlying weight of outstanding debts. ·