Inflation is likely to normalise within a year, bringing with it the prospect of interest rate rises, a Bank of England committee member has said.
Monetary Policy Committee member Professor Kristin Forbes said that the UK economy is experiencing a “solid, sustainable recovery” that is not likely to be damaged by the current low rate of inflation.
Speaking exclusively to The Yorkshire Post, Professor Forbes said external factors were largely responsible for the dramatic fall in inflation to 0.3 per cent in January, but that these were expected to “fade fairly quickly”.
Lower prices in oil and gas, energy, commodities and food, along with “the lagged effect of sterling’s appreciation” have led to the sharp decline in inflation, but there is no evidence this will be a long-term trend, she said.
She said: “We shouldn’t let the headline inflation figure detract from the underlying strong fundamentals in the economy.
“That means we will need to start to think about normalising interest rates.
“We don’t know when yet, and when will depend on the data, it will depend on what happens with wages.”
While wage growth has been “the key piece missing” from the recovery, average weekly earnings (AWE) data has shown sharp increases in recent months, Professor Forbes said. Year-on-year growth stands at 2.5 per cent but this rises to five per cent in quarterly comparisons.
“Wage growth has turned around and we expect it to continue to strengthen. At some point that will feed through into higher inflation,” she said.
Professor Forbes, who joined the Bank of England in July 2014, said that while inflation could fall further, there was no evidence to suggest that the UK is at high risk from ingrained deflation.
The strength of consumer spending is one indicator that the UK could weather low or negative inflation. Professor Forbes said: “You worry about deflation for a couple of reasons.
“One is if consumers expect prices to be lower in the future, so they delay purchases. We don’t see any evidence of that happening in the UK - if anything, consumption growth is very strong and increasing.
“Also, I find it very hard to believe that the UK consumer will delay buying that TV they want because it’ll be 0.1 per cent lower in a year.”
Deflation is also unlikely to make it harder to pay back debts while interest rates remain at historic lows, she said.
One issue could arise if employers were to justify lower wage rises on the basis that prices were falling due to deflation.
“That’s the effect we’re looking at very closely; the evidence we’ve seen doesn’t suggest that’s happening yet,” she said.
Professor Forbes, who was in the region as part of a visit organised by the Bank of England Agency for Yorkshire & Humber, also urged more research to be done on the impact of low interest rates on economic inequality, as it is “impossible to say anything conclusive” on the subject.
While low interest rates have been key to the UK’s recovery, there could be costs associated with low rates in a normalised economy, she added.
With the interest base rate at an historic low of 0.5 per cent, Office for National Statistics (ONS) data this month showed inflation had taken a tumble to 0.3 per cent - the lowest since records began in 1989.
While the Bank of England said it may cut interest rates further if long-term deflation were a risk, Professor Forbes said the next interest rate move is likely to be upwards.
While interest rates could be lowered if the Bank believed inflation would remain below its two per cent target over a two year-plus horizon, its preference would be for a rise.
This would enable it to lower rates in future if the economy faces another negative event, Professor Forbes added.