80 per cent chance deflation will persist for 2015

28 May 2015

Academics have calculated there is around an 80 per cent 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, who believe that inflation will begin to return to its two per cent 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 cent 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 two per cent.

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.

 

WBSFS probability charts on GDP and inflation

 

Commenting on the latest Warwick Business School forecasts, timed to coincide with publication of the second estimate of GDP growth from the ONS, Professor James Mitchell, of the Economic Modelling and Forecasting (EMF) Group at WBS, 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 one per cent has more than doubled from 42 per cent two quarters ago - to the current expectation of more than 99 per cent.

“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.

Professor Ana Galvao, of the WBSFS, said: “Our forecasts indicate that there is a higher risk of deflation in 2016 than other professional forecasters suggest. The WBSFS is not as confident as the Bank of England that inflation will begin to return to its two per cent target in 2016. We estimate that there is still a one-in-two chance of deflation in 2016.

“These high expectations of deflation are not expected to slow GDP growth in the UK. In this sense, we are predicting that any deflation the UK experiences will be ‘good’ rather than ‘bad’.

“The latest, revised GDP data from the ONS for 2015 Q1 confirm that growth did indeed moderate in the first quarter of 2015. But the WBSFS, which condition on these latest GDP data from the ONS, show that looking forward through 2015 growth is most likely to be between two and three per cent, at around its pre-crisis trend growth rates.”

But Professor Anthony Garratt, of the WBSFS, added: “There are some remaining downside risks to economic growth prospects, in particular as the economy moves into 2016. There is a 30 per cent chance of GDP growth of less than two per cent in 2016. This suggests that one should not presume that economic growth will pick up to historically 'normal' levels of growth around 2.5 per cent per annum.”

Professor James Mitchell teaches Economics of the Business Environment on the Warwick Global Energy MBA and Managing in a New World on the Warwick MBA by full-time study. Professor Anthony Garratt also teaches Managing in a New World on the Warwick MBA by full-time study.

 

 

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