0% Inflation: What does it mean for your business?

Kingly Brookes, March 26th, 2015

On Tuesday 24th March the latest figures revealed that the current rate of inflation is 0%, meaning the cost of living in February 2015 is the same as it was in February 2014. Although in theory this does not sound like big news, it is actually a very unusual situation to be in. According to statistics from inflation.eu, this is the first time there has been no inflation since the 1950’s (as measured by the Consumer Prices Index).

CPI Inflation Chart

Source: http://www.inflation.eu/inflation-rates/great-britain/historic-inflation/cpi-inflation-great-britain.aspx

 

The two main ways of measuring inflation in the UK are by the CPI (Consumer Prices Index) and the RPI (Retail Prices Index). Both indexes measure the price changes in a ‘basket’ of goods and services. However, the goods and services measured in each index are not the same, and the formulae used to calculate each one is different, meaning that RPI and CPI are almost never the same. The government and the Bank of England argue that a small amount of inflation (say 2%) is a good thing, because a rise in the price of goods and services usually reflects a healthy economic environment.

The recent drop in inflation has been caused by a number of factors, including lower fuel prices. Interestingly however, fuel prices have risen over the last few weeks, meaning they were not one of the causes of this month’s 0% inflation rate. Another factor has been the supermarket ‘price wars’, meaning many supermarkets have slashed the price of food. According to the Office for National Statistics, it was a combination of food, furniture, non-alcoholic drinks, household goods and ‘recreation and culture’ products such as books and games that have caused the recent drop. In addition to this, the pound has been strengthening against the Euro, making imports cheaper.

 

Why is a 0% inflation rate good?

One of the biggest advantages of 0% inflation is that the prices for many goods and services are lower, meaning lower costs for your business. You may decide to use this as an opportunity to increase investment whilst prices are low. A non-existent rate of inflation also gives your customers more spending power, meaning that in theory they are more likely to buy your goods and services, and buy in greater amounts. However, this can be negated if the inflation rate is expected to drop further, meaning consumers hold off on purchases until they feel that prices have bottomed out. As it is generally expected that prices will fall further next month, meaning we’ll find ourselves in a period of deflation, you may find that some of your customers are holding off on purchases, particularly if you sell items such as televisions, where there is often no urgency to make the purchase.

According to Kristin Forbes, member of the Bank of England’s monetary policy committee: “Low inflation is unlikely to persist because the recent sharp fall in the price index is driven primarily by the sharp fall in energy and food prices. In fact, Bank calculations suggest that around three-quarters of inflation’s deviation from our 2% target can be explained simply by recent price falls in these sectors. What’s important to realise is that even if energy and food prices stay at current low levels, this does not mean inflation will also stay low. Inflation is calculated as the change in the prices for a basket of goods relative to one year ago.”

In summary, no inflation may be a good thing, provided it only lasts for a short period of time.

 

Why is a 0% inflation rate bad?

Confidence in the economy can have a huge impact on a country’s economic performance. When the recession took hold around 2009, prices sharply dropped because people avoided making purchases due to their uncertainty about the future. Therefore, we may also find that businesses start to delay purchases. Even when excluding the impact of food and energy prices, inflation is still at a 10-year low. To many people this demonstrates that the UK economy is still very fragile, and has not yet fully emerged from the recent recession. This is also reflected by the fact that interest rates are still being held at the all-time low of 0.5%, and they have stayed at this level for six years now.

Two other factors for business owners to bear in mind are wages and debts. For example, if you’ve promised your staff a 4% increase in wages next month, this increase might not be sustainable for your business. However, it will be very difficult for your staff to accept this if they are expecting a 4% increase. With regards to debts, it is important to understand that although prices have fallen, debts have not, so you may find it more difficult to repay debts.

 

Our View

The current inflation announcement , albeit welcome, does not yet constitute a trend that one should be too concerned about. When reviewing business plans and business performance, the effects of wage inflation and fiscal drag are more important indicators when reviewing profitability and productivity. The oil price drop is more supply side than demand side (geopolitics and fracking), and so a keen eye on the oil price movement is key to being ahead of the curve on changes affecting the business.

 

 

If you would like to find out more about how we can help your business, please contact Martin Jones on 0207 292 8850 or on martin.jones@kinglybrookesllp.co.uk.