Deflation predicted to return as oil prices fall

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Falling oil prices will likely lead to another bout of deflation and means the Monetary Policy Committee should “take its time over raising interest rates”, says Capital Economics.

The price of oil is at a six-month low, with a barrel now costing under $50.

CPI inflation was 0 per cent in July, although core inflation – which is a measure that strips out certain items that face volatile price movements – was at 0.8 per cent.

Capital Economics says “domestic price pressures are still weak”, meaning inflation is likely to strengthen only gradually next year.

Capital Economics senior UK economist Samuel Tombs says: “Looking ahead, inflation is likely to turn negative again for a couple of months. Supermarket competition should drive petrol prices down before long. In addition, British Gas will cut its gas prices by 5 per cent in late August and other utility companies are likely to follow suit.

“And while inflation is likely to strengthen when the anniversary of the sharp fall in oil prices in late 2014 is reached, we expect it to remain below the MPC’s 2 per cent target during 2016. Although pay growth has risen, productivity is reviving too, keeping a lid on firms’ unit wage costs.

“Meanwhile, weak growth in global demand and a supply overhang should keep commodity prices subdued. As a result, the MPC should be able to take its time over raising interest rates next year.”