The UK is heading for a renewed period of deflation. The fall back in oil prices to below $50 per barrel will bear down on petrol prices soon. In addition, sterling has continued to appreciate and on a trade-weighted basis it is now 18% higher than it was two years ago. This will exert further downward pressure on food and consumer goods prices over the next year or so. Admittedly, the Monetary Policy Committee (MPC) is likely to look through these transitory influences and focus on domestically-generated inflation. But it does not seem to be strengthening either. Although pay growth has picked up, the fall back in employment in the three months to May suggests that the economic recovery is now being fuelled by productivity gains. If, as we expect, productivity continues to revive, keeping inflation low, then the MPC can afford to take its time over raising interest rates.
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