What is deflation? And why is it great news for you?

We explain

The UK has officially entered into deflation, the Office for National Statistics (ONS) confirmed today.

But what is deflation? And what does it actually mean for you? LondonlovesBusiness.com explains…

So first a quick explanation of inflation, which is normally the status quo:

The rate of inflation is how much prices of everyday goods and services are going up. It’s calculated by the ONS looking at things that we buy regularly, such as bread, yoghurts, shoes, plane tickets and petrol. More about what actually makes up the inflation basket here.

Statisticians study how much the cost of those things has risen and come up with an average for the year, which it released every month. It’s called Consumer Price Inflation (CPI). There are different ways inflation is calculated but the CPI is the main one.

It’s usually between 2% and 5%, but since the recession it’s been much lower, at around 0.5%, meaning prices haven’t been going up as quickly.

There’s more on how inflation is worked out here.

When people say inflation is falling, this doesn’t mean prices are falling. It means the rate they are rising is less than it was in the previous month’s calculations.

When prices are falling, that’s deflation. You’ll see it as a figure with a minus sign in front, eg, -1%.

In some countries deflation is common, but in the UK it’s extremely rare. In fact, we haven’t seen it since 1960.

Why is it good news for me?

Shopping trolley basket inflation prices money economy

Broadly speaking, if inflation is at 2% for example, the cost of things you buy is going up by 2% a year, meaning you’d have to have a 2% pay rise for prices to “feel” the same.

When people talk about the “squeezed middle” or “feeling the pinch” it’s often down to the fact they haven’t had a pay rise, or only had a small pay rise, so money is slightly tighter than it was before.

In the UK, pay hasn’t risen much at all in the last few years so many of us will be familiar with this situation.

However, deflation means things are getting cheaper. It means the cost of a banana or a watch is less than it was a year ago, making your pay spread further, even if you haven’t had a pay rise.

It’s great news for ordinary workers.

However, some people think it’s bad for the economy because it encourages businesses not to spend money. When businesses see prices falling, they hold off buying new stock or equipment because they think prices are going to drop further. Meanwhile, they’re making less money and more likely to not be able to pay their bills.

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