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Will deflation have an impact on the general election?

Next month’s general election will take place at a strange time for the UK economy. Official figures have just revealed that the main measure of inflation has hit 0% for the first time in half a century.

Meanwhile, interest rates remain at their all-time low of 0.5%, unemployment continues to fall and there is fair amount of optimism about the state of the economy, if not the public finances.

But is 0% inflation – and the prospect of deflation being recorded in the coming months – anything to worry about?

Many analysts say we should be sanguine about Britain’s current period of low or non-existent inflation because it is primarily due to falling fuel and food prices – both of which have been caused by the slump in the value of oil since last summer. If low inflation were due to a dip in economic activity, on the other hand, that would be a much more serious matter.

As inflation measures the year-on-year change in prices, the rate is likely to start creeping back up again in the second half of 2015 as the impact of the lower oil price “falls out” of the system.

In the short-term, though, stagnant prices are good news for consumers, who may well be enjoying falls in grocery, utility and petrol bills at the moment, as well as for savers and of course peer-to-peer (P2P) lenders. Both groups will see the returns on their deposits or loans grow more quickly in real terms.

But crucially, low inflation reduces the pressure on the Bank of England to raise interest rates – if the bank were to do so at the moment, the resulting fall in spending would practically guarantee a period of deflation. In fact, the money markets now do not expect the base rate to pass 1% until 2017 at the earliest.

Taking a more long-term view, this means returns on deposit accounts, say, look set to remain at rock bottom for some time to come.

Research from investment firm Hargreaves Lansdown shows that £1,000 put into a typical bank savings account at the time of the last election in 2010 would be worth £1,045 today – but just £936 in real terms given that CPI inflation has risen by 12% over the last five years.

Once inflation is up and running again as predicted later this year, these real losses could well be expected to be repeated over the course of the next parliament.

Which brings us to the forthcoming election. Over the last few years, many people have decided to take the risk of turning to the stock market as a way of generating better returns than are available on cash.

But the current uncertainty over next month’s poll – in particular the fact that another coalition of some form looks inevitable – appears to be causing jitters among private investors.

Hargreaves says its Investor Confidence Index has this month suffered its biggest fall since May 2012, when the eurozone crisis was in full swing. Shareholders think an unclear result in the General Election has the potential to create a turbulent six months or so for UK markets, although the long-term sentiment remains fairly positive.

For P2P lenders, however, the outlook is sunnier: there is no reason factors such as deflation, continued low interest rates and pre-election nerves should have any impact on the creditworthiness of the individuals they lend to.