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Don’t get tempted by the low inflation trap

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By Simon Danaher - March 25, 2015

What does a zero rate of inflation in the UK mean for expats? 

The UK’s rate of CPI (Consumer Price Index) inflation fell to zero in February, its lowest rate since at least the 1960s, meaning goods cost roughly the same now as they did a year ago.

This unexpected news is arguably very good for those living in the UK.

Two of the major factors contributing to this unprecedented environment are the significant falls in oil prices this year, which have reduced prices at the petrol pumps, and the ongoing price war between the UK’s leading supermarkets, which has made staple food goods much cheaper.

Low Inflation Trap

The Office for National Statistics, which compiles and releases the data, said the prices of fuel and food have now fallen or remained unchanged in the year for 18 and 10 consecutive months, respectively, and in February, the 12-month rates for both groups were the lowest on record.

However, there a few things people, particularly expats with assets in the UK, should bear in mind.

Sterling has had a good run this year, which has been supportive of those with any income coming from the UK, such as pension benefits. However, a flat inflation rate will raise some concerns that the UK is about to enter deflation, which could have a damaging impact on the economy.

The fear stems from the idea that consumers and businesses hold off making purchases in the hope items will continue to get cheaper.

The likelihood of the UK actually entering deflation is slightly diminished by the fact that the main downward pressures are on food and fuel – not purchases people tend to put off. However, currency markets are fickle and there may be some short term impact on currency prices, so watch out for this.

Another factor is borrowing. When inflation is low, people are more inclined to borrow. This is particularly the case at the moment when interest rates also continue to languish at historically low levels.

In fact, according to a recent PwC report, the average level of unsecured debt per UK household will hit £10,000 by next year. While there are no figures for expatriates, one can assume levels of debt are also creeping up.

However, high debt levels can of course be dangerous.

Borrowing may seem to make sense when it is cheaper and your money is going further, but the temptation to push your debt limits to the maximum when working out your annual budget could lead to real financial problems in the future. This is because, while the debts may seem manageable now, even a small rise in interest rates could have serious consequences later on.

This could be particularly painful if the increased costs of servicing debt comes at the same time as a weakening pound.

If you want to know more about how low levels of inflation could impact your finances, click the link below to talk to our financial planning experts.