A turning point for price expectations

Here is an important turning point for the British economy and one that the Bank of England was expecting when the latest Inflation Report was published at the back end of November.

There has been a sharp downward shift in people’s expectations of price inflation for the year ahead. The average inflation rate expected over the next year is 2.8 per cent, compared with 4.4 per cent in August – this is the biggest move in price expectations in the nine years over which the Bank of England/GfK NOP Inflation Attitudes survey has operated.

Visible price reductions on the high street and on petrol forecourts will have played a role. Once people start to notice lower quarterly energy bills and the next wave of price discounts at the tills of food stores, inflation expectations can be expected to head south once more. The cut in VAT will accentuate this process.

But just as the Bank of England was worried that rising inflation expectations could stimulate a wage-price response, so it will be concerned to avoid expectations of price deflation since this might lead consumers to postpone spending and deepen the demand-led recession. The depreciation in sterling will be one factor helping to keep the economy away from deflation’s door in 2009.