According to the Office for National Statistics, the consumer prices index (CPI) dropped to 0 per cent in February – down from 0.3 per cent in the previous month. The fall was driven by declines in the cost of transport, food and non-alcoholic beverages, with the slide in the price of oil continuing to hold back prices.
The news was welcomed by chancellor George Osborne, who tweeted: “Inflation at zero is a first for the British economy. Low inflation due to falling oil prices is good news for family budgets.”
However, not everyone will be applauded the plummeting inflation rate, especially those concerned that entering a deflationary environment will add further strain on the UK’s economic growth.
The Bank of England could find the fall particularly troublesome, given that it is expected to start lifting UK interest rates at some point in the future.
Bank governor Mark Carney said earlier in the year that he expects inflation to enter negative territory at some point, but added that it will move towards the official 2 per cent target in time. He also reassured that the country is not heading into a deflationary spiral, as the drivers of falling prices are temporary.
“[A] debt-deflation dynamic was at the core of the Great Depression and in the Japanese malaise following the collapse of the asset bubbles of the 1980s. It would be a particular concern if the pace of wage growth were to follow prices down. There is no evidence of that in the UK, where wage growth has picked up over the past six months,” he said at a speech in Sheffield.
“And more broadly, following the 2008 financial crisis debt deflation has been the dog that hasn’t barked. But we shouldn’t rest too easy – there are several reasons why the dog might have just been sleeping, and central banks need to be vigilant against the risk that recent low inflation stirs it from its slumber.”
Despite Carney’s reassurances, not all are convinced that the move towards deflation can be overlooked.
David Lamb, head of dealing at the foreign exchange specialists FEXCO, points out that Bank of England chief economist Andy Haldane has already suggested cutting interest rates even further to stave off deflation, noting that this prospect is the reason behind sterling’s recent fall against the dollar and the euro.
"Consumers may be revelling in cheaper prices, but for economists this is a code red moment. While there is no surprise at the fall in inflation, both the speed and the scale of the drop are alarming. We are in an oasis on the edge of an abyss,” Lamb said.
“Mark Carney has breezily predicted that though inflation would turn negative in spring, Britain would escape a deflationary spiral. But with inflation in freefall, that assessment is now looking dangerously optimistic.”
“It now seems certain that Britain will fall into deflation in March. This is unknown territory, and we should expect policymakers to take drastic action to prevent deflation taking root.”
Maike Currie (pictured), associate investment director at Fidelity Personal Investing, is also cautious about falling prices being seen as unequivocally good news.
Just two weeks ago, she reminds, Carney warned that warned UK households could face a “clear and present danger” if the inflation dropped to the kind of spiralling prices that caused the Great Depression of the 1930s.
“Deflation is dangerous because it causes companies and consumers to do the exact thing that causes more deflation – delay spending in the hope of further price falls in future. With inflation now at zero, the UK is now just one shock away from deflation,” Currie said
“As it stands inflation is being pulled down by the falling oil price and the ongoing supermarket discount price war. Strip these (somewhat exceptional) factors away and core inflation – a measure of inflation that excludes transport and food - has also fallen to 1.2 per cent in February, from 1.4 per cent in January, and 1.3 per cent in December.”
“The fall in core inflation is worrying and raises question marks over whether the UK is suffering from unhealthy deflation or welcome disinflation, which lines the pockets of consumers and boosts the economy.”
Currie adds that funds that invest in companies with strong brands benefit from pricing power could work well in a deflationary environment, as their unique products mean they have more scope to increase prices regardless of the wider economy.
She highlights the CF Lindsell Train UK Equity and Fundsmith Equity funds as two that specialise in these types of businesses.
Nick Train’s five FE Crown-rated CF Lindsell Train UK Equity fund appears on the FE Select 100 list, where it is commended for its strict investment process, genuinely long-term approach and concentrated portfolio.
The FE Alpha Manager’s top holdings include Unilever, Diageo, Heineken and Burberry.
Performance of fund vs sector and index since launch
Source: FE Analytics
As you can see from the above graph, the £1.4bn fund has outperformed its average peer and the FTSE All Share by almost 120 percentage points since its launch in July 2006 with a return of just over 290 per cent. The consistency of those returns have been impressive – the fund is first quartile in each of the last seven full calendar year, as well as over 2015 so far.
CF Lindsell Train UK Equity has a clean ongoing charges of 0.77 per cent and yields 1.82 per cent.
FE Alpha Manager Terry Smith has a similar approach on his five crown-rated Fundsmith Equity fund. The fund, which attempts to keep trading to a minimum, has just 28 holdings, in companies such as Microsoft, Imperial Tobacco, Dr Pepper Snapple and Domino's Pizza.
Since launch in November 2010, the fund has returned 208.69 per cent, compared with the 171.20 per cent rise in the MSCI World index and the 150.75 per cent average gain from IA Global sector. It also outperformed the sector in 2011, 2012, 2013 and 2014 but is lagging over 2015 so far.
Performance of fund vs sector and index since launch
Source: FE Analytics
Fundsmith Equity has a clean OCF of 0.99 per cent and yields 1.04 per cent.
However, as Carney has maintained, a fall into a 1930s-style deflationary spiral is – at the moment – seen as a remote prospect.
Vicky Redwood, chief UK economist at Capital Economics, concedes that the UK is “within a whisker of deflation” and will probably get there soon. But she is in the camp that this will not be a negative for the economy.
“It looks odds on that inflation will turn negative in March, when the cut in gas prices by British Gas, the utility company with the biggest market share, will show up in the inflation figures for the first time. And inflation is then likely to remain around zero/slightly negative for the rest of the year,” she explained.
“But we doubt that this will turn into more serious and engrained deflation, given that inflation expectations seem well anchored. We still think that deflation in the UK will be a ‘good’ development, giving households’ incomes a welcome boost and supporting the economic recovery this year.”