The Consumer Price Index (CPI), the main measure of inflation in the UK, has turned negative for the first ever time, prompting speculation that the UK may be entering a period of deflation.

The CPI, which measures the average price paid for a variety of consumer products and services, fell by 0.1% between April 2014 and April 2015 – the first time it has done so since it was formally introduced in 1996. There are concerns amongst mortgage lenders that if the CPI falls for a long period, it could trigger a decrease in wages and, subsequently, a fall in the numbers of people looking to take out mortgages.

The CPI has been driven down by a number of factors over the last 12 months, including a sharp drop in petrol prices and also a decrease in sea and air fares. The UK has not seen trends like this since 1960, when comparative historical estimates suggest the CPI was falling by approximately 0.5% for three months consecutively. Although the fall in April 2015 initially suggests that UK inflation has stalled, economists say that this does not automatically signal that the UK is experiencing ‘deflation’.

Deflation is used by economists to describe a period where the fall in prices is sustained over a long period of time, rather than just one month, as has been seen in the UK. Economists currently believe that the UK will not reach this stage of ‘deflation’, and that prices will rally again over the next few months. Rather, they suggest that the UK is currently experiencing a period of ‘negative inflation’, where the fall in CPI is an isolated one, and consumers are encouraged to keep spending by lower prices and cost of living.

Should we worry?

The worry of deflation comes when the CPI is falling for so long that consumers stop spending money. This happens due to an assumption that it will be cheaper to buy items such as cars or televisions in the future, when the price has fallen further. This can lead to stagnation in the economy, and consequently can start a decrease in wages. Once wages have started to fall, people are less likely to feel comfortable committing to any long-term borrowing, such as taking out a mortgage, as the repayments are going to take up an ever-increasing amount of their monthly expenditure.

Whilst it seems unlikely that the UK is going to enter a period of deflation, it is important for mortgage lenders to understand the potential effects of a deflationary period, and to understand customers’ anxieties about lending during these times.

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