UK to remain in deflation trap until 2012, economists warn

UK to remain in deflation trap until 2012, economists warn
Britain will be mired in a deflation trap for years despite the radical efforts of the Bank of England to pump extra cash into the economy, economists have warned.

By Edmund Conway
Last Updated: 10:26PM GMT 21 Mar 2009

The forecast, by a team at BNP Paribas, states that prices in Britain will keep falling for at least another two-and-a-half years, as Britain suffers an apparently intractable bout of debt deflation.

The warning comes only days before official figures confirm this Tuesday that the Retail Price Index has dipped into negative territory for the first time in almost half a century.
It also follows a warning from the Bank itself that the UK is now exhibiting early signs of becoming stuck in debt deflation − the combination of falling prices and rising debt burdens that afflicted the US during the Great Depression.

But while many assume the combination of near-zero interest rates and a heavily-devalued pound will help prevent falling prices from becoming entrenched, and may stoke inflation, the BNP Paribas economists said they expected deflation to persist all the way until 2012. Furthermore, the fall in prices would be broad-based across the economy, pushing into the red not only the RPI but also the Consumer Price Index, which the Bank's Monetary Policy Committee targets

Alan Clarke, UK economist at BNP Paribas, said: "Our revised economic forecasts for the UK are the most pessimistic in the market. We expect GDP to contract by more than 4pc this year and by a further 1pc in 2010. We expect deflation to set in during 2011, even earlier were it not for the VAT hike [which will follow the temporary cut in the tax this year]."

"Over the medium term, we expect the unemployment rate to surge to above 10pc − well above neutral. This will exert significant downward pressure on inflation, turning negative in 2011."

The forecast is based largely on the bank's prediction that the unemployment rate will soar to 10.4pc of the workforce by 2011, depressing the wider economy and underlines the disparity between economists' expectations for the coming years.

The Office for National Statistics will on Tuesday announce that the annual rate of change in the RPI has dropped beneath zero for the first time since February 1960, most likely falling to -0.6pc. It is also likely to say that CPI inflation has fallen to around 2.5pc. The CPI does not include the effects of either house prices or mortgage interest payments, and so has been less affected by the falls in property values over the past year.

http://www.telegraph.co.uk/finance/financetopics/recession/5028673/UK-to-remain-in-deflation-trap-until-2012-economists-warn.html

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