Britain is in deflation, what does it mean for you?

New government figures have revealed that Britain has fallen into deflation for the first time since 1960 - so that prices are actually falling rather than rising.

In fact they are 0.1% lower than the same time last year. On the face of it, this looks like great news, as the cost of living is finally falling, and we will all have more money in our pockets. But there is also a serious risk associated with deflation.

We can expect to enjoy a bumper summer thanks to deflation. Nick Dixon, Investment Director at Aegon UK, said: "This paired with a strong pay growth and falling unemployment means that consumers could be in for a truly great British summer".

Why?

We are benefitting from the most aggressive supermarket price war in decades, with the big four under extreme pressure to match the prices set by the discounters, or pay the price of losing business. BRC Director General, Helen Dickinson, said: "April saw the 24th consecutive month of falling shop prices and the 25th consecutive month of falling non-food prices." She added that food prices remain at a record low for a second consecutive month.
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Meanwhile, higher oil production has pushed down the oil price. It means energy bills and the price of fuel have both been falling - easing budgets still further. We are now seeing the beginnings of increases in the oil price, but they remain low - at roughly $66 a barrel. Staple commodities such as wheat and corn are also between a quarter and a third lower than this time last year.

The risks

However, deflation is not an unalloyed joy. Anyone with debts loses out, because each pound in our pocket is worth more in real terms - so each pound we owe to someone else is worth more too. With deflation at 0.1%, it's not going to make an enormous difference, but if deflation continues it will make paying off mortgages and credit cards look like bigger mountains to climb.

There's also a risk that we get stuck in a period of deflation. The problem with falling prices is that people hold back from spending because they expect things to keep getting cheaper, so companies sell less, and make less money.

This raises the risk of job cuts and wage cuts - and once wages start to fall there's a risk of getting stuck in a deflationary spiral. Prices fall, so businesses sell less. It means they produce less and cut wages, so people buy less. With too many products and not enough money in the system, prices fall again, and so the cycle continues.

The good news

Fortunately the experts believe this won't happen. Mark Carney, the Governor of the Bank of England has been predicting deflation, but that it would only be for a short period. It helps that the falls are driven by food and fuel. Maike Currie, associate investment director at Fidelity Personal Investing comments: "Food, fuel and energy are all essential items to the consumer. No-one is going to delay their purchases of any of these in anticipation of future prices falls. After all, you need to eat, keep warm and get to work. The effect of these factors are therefore likely to be relatively short-lived."

Helal Miah, investment research analyst at The Share Centre adds that: "Fears of prolonged deflation have abated with oil prices recovering."

Mark Taylor, Dean of Warwick Business School, is a former Bank of England and International Monetary Fund economist and is a Professor of Finance. He says: "This kind of deflation is not bad for the economy because it's coming from the supply side - weak energy and food prices - rather than any fundamental weakness in the demand side or consumer spending. It's also expected to be temporary as the oil price has rebounded and commodity prices have stabilised. Deflation is only bad for the economy when prices are expected to continue to fall and people postpone consumption, which weakens demand and leads to further falling prices, in a vicious downward spiral. But with average earnings rising in the UK and consumer spending still buoyant, a temporary dip in prices is not a problem - in fact, consumers are very slightly richer as a result."

It means, therefore, that we may be able to enjoy a brief summer of lower prices while they last, without having to worry about paying the price further down the line.

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