UK set for deflation

Official figures are today expected to show the UK suffered its first bout of deflation in almost 50 years last month.

Economists predict the Retail Prices Index (RPI) to have slid from 0% in February to minus 0.5% in March as deep interest rate cuts filter through to lower mortgage payments.

This would be the first negative reading for RPI - which governs private sector wage deals and pension payments - since March 1960.

The official measure of UK inflation, the Consumer Prices Index (CPI), is also predicted to have fallen last month after February's shock rise to 3.2%.

Experts are expecting CPI to have slowed to 2.9% in March, as lower energy costs drive it closer to the Government's 2% target.

Previous Office of National Statistics figures have defied predictions of a fall into deflation for both RPI and CPI as the weak pound has forced retailers to hike prices to offset rising import costs.

However, while the recession has not caused official deflation in the UK yet, negative RPI could have serious consequences for many households because of its role as a benchmark for wage settlements.

It is also used as the basis for annual rises in State pension payouts and other benefits, as well as annuity payments for private pensions and rates for index-linked savers among others.

RPI has been pulled lower than the official measure of inflation because, unlike CPI, it includes housing costs and mortgage payments, which have been slashed by plummeting house prices and interest rates.

Last month's fall in RPI is expected to reflect February's cut in interest rates to 1%.

The Bank of England has dramatically hacked interest rates and injected £75bn (€84.2bn) of newly created money into the flagging economy as it tries to counter the UK slowdown and rates have since been cut further to a record low of 0.5%.

David Page, economist at Investec, said CPI was likely to have reversed February's unexpected positive move as prices for the month are compared to the same period last year, when petrol prices were beginning to rise.

He said the figures would also be skewed by the inclusion of higher airfares around the Easter school holidays last March, as the two-week break fell in April this year.

Mr Page said the slide below zero for RPI was an important milestone.

"We would hesitate and shy away from calling this deflation but clearly it is significant that we are seeing the lowest rate of RPI for nearly 50 years," he said.

He said inflation was expected to continue its downward march over the next couple of months as further cuts from utility companies filter through.

Base effects are also predicted to play an increasing part as prices are compared to the period of surging oil, gas and electricity costs last year.

The ONS said February's rise in CPI was due to sharply increased food and drink inflation, which rose by 11.5% on an annual basis in the month as the weak pound and a poor vegetable crop in Spain pushed prices higher.

This resulted in another letter from Bank of England governor Mervyn King to Chancellor Alistair Darling explaining why the "somewhat higher than expected" increase meant inflation remained more than 1% above the British government's target. He is not expected to write a letter this month.