South: 80% chance deflation will persist for 2015, says Warwick Business School

Academics have calculated there is around an 80% chance that the UK will experience deflation for 2015 after the ONS revealed the revised GDP figures.

And they believe there remains more than a one-in-two chance that this deflation will persist into 2016, according to the latest forecasts from the Warwick Business School Forecasting System (WBSFS).

The WBSFS has revised up its previous assessment of the downside risks to a breach of the inflation target. These elevated risks of deflation in 2016 are in contrast to the assessment of the Bank of England, which believes that inflation will begin to return to its 2% target during 2016.

However, this deflation and low inflation is not expected to slow GDP growth in the UK. The WBSFS predicts the UK economy is likely to grow around 2.5% per annum in both 2015 and 2016. But despite this the forecasts emphasise the uncertainties and indicate a clear downside risk to GDP growth in 2016, with close to a one-in-three chance of 'weak' growth of less than 2%.

Instead of using a single forecasting model or relying on the judgement of the Bank of England’s monetary policy committee, the WBSFS combines five state-of-the-art econometric models to produce judgement-free macroeconomic forecasts for UK GDP growth and CPI inflation. These forecasts are updated each quarter to reflect the latest data.

By using model averaging, following well-established methods in statistics, meteorology and economics, the WBSFS takes a weighted combination of each models’ forecasts, where higher weights are awarded to models which show the better recent forecasting performance. The WBSFS quantifies and communicates the forecast uncertainties by producing probabilistic forecasts.

Commenting on the latest Warwick Business School forecasts, Professor James Mitchell of the WBSFS, said: “The deflationary risks to the UK economy have risen sharply over the last half year. There is now close to a four-in-five chance that the UK will experience deflation through 2015 and there is more than a one-in-two chance that this deflation will persist into 2016.

“This is because, according to our judgement-free forecasting system, the probability of inflation falling below the Bank of England’s lower target of 1% has more than doubled from 42% two quarters ago - to the current expectation of more than 99%.

“This follows UK inflation recently dipping below zero due to weaker oil, food and import prices; and is consistent with continued stagnation and possible deflation in many of the UK’s export markets. Business and policymakers should be increasingly alert to these downside risks; accordingly, we do not expect the Bank of England to change the bank interest rate any time soon.”