Inflation is heading rapidly back towards its target and, by the end of the year, it should be close to just 1 per cent. Indeed, the UK has more to fear from the risk of deflation than a renewed spike in inflation. The temporary factors that have supported inflation have waned and inflation is now under downward pressure from a number of sources. The rise in the pound suggests that import price inflation will soon be negative. The biggest source of costs for many firms is wages – and pay growth is just 2 per cent. Meanwhile, competitive pressures are building as a result of Britain’s recent return to recession and the large amount of slack in the economy that has yet to be worked off. So after a prolonged period of surprisingly high inflation rates, inflation could now fall a lot further than is widely expected.
Victoria Redwood is chief UK economist at Capital Economics, the macro-economic research consultancy.
June’s rapid fall in the Consumer Price Index is good news for consumers faced with still muted wage growth. But it may overstate the deflationary forces in the UK economy if it simply reflects early summer sales to stimulate spending during the recent downpours. The fall in inflation may slow if the US heatwave continues to push food prices higher and a pick up in activity in China adds further support to the oil price. It is ironic that lower food prices were a key contributor to the lower figure when the headlines are all pointing the other way. In the short term inflation has been tamed but not defeated. Investors need to protect themselves against the tail risk that extreme monetary policy could re-ignite inflation. Exposure to real assets, like commodities and property, and to inflation-linked bonds continues to have a place in a well-diversified portfolio.
Tom Stevenson is investment director at Fidelity Worldwide Investment.