The Bank of England needs to cut interest rates as there is a risk the UK could go into a period of deflation with a drop in household incomes, an economist has urged.
Julian Jessop, economics fellow at the Institute of Economic Affairs, told Express.co.uk: “If the Bank of England doesn’t cut interest rates sooner rather than later, then the risk of deflation is bigger than it needs to be.”
He said that while a drop in energy and food prices could provide some welcome relief for households, a general decline in prices is often associated with a fall in incomes, piling pressure on household budgets.
He explained: “The inflation target is two percent, not zero, for a reason. Inflation can be too low, and there are a number of problems with that.
“One is you need a little bit of inflation in the economy just to make it easy for relative prices to adjust.
“A little bit of inflation with some prices rising faster than others is a good way for people to decide what to buy and what to make.
“There’s also a problem with falling prices when people have high levels of debt because falling prices tend to be associated with falling incomes as well.
“Debts are fixed in nominal terms. During periods of deflation, it becomes much harder for people to service their debts because their incomes are probably falling as well as prices.
“Interest payments and debt servicing takes up a bigger proportion of your income.”
Asked how this could affect people with mortgages, Ms Jessop said: “Your mortgage is fixed in cash terms, you have to pay whatever it is, come what may.
“If your income is falling because prices are generally falling, then the burden of that debt becomes higher relative to your income.”
Mr Jessop said he does not anticipate there will be a significant period of deflation later in the year, but he added that the Bank of England needs to cut rates soon to avoid that possibility.
His comments come after the rate of inflation fell in the latest figures, dropping to 3.4 percent for the year to February, down from 4.2 percent in January.
Claire Exley, head of advice and guidance at wealth manager Nutmeg, told Express.co.uk: “For mortgage holders today’s inflation data may not be good enough news.
“If there had been a more significant reduction in the rate of inflation, there would have been more scope for the Bank of England to consider a cut to interest rates sooner rather than later.
“A reduction to the base rate, would in turn feed through to mortgage rates and potentially provide some relief, particularly for those who will need to remortgage in the coming months.
“That being said, it’s always worth shopping around – expectation is that there will be interest rate cuts this year and some providers are starting to factor this in with the rates they are offering.”
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