Deflation could be sparked by falling oil prices

FALLING oil prices could help provide the UK economy with a “substantial boost” over the next three years, according to research.

However, the good news from the Ernst & Young ITEM Club comes with a warning – lower oil prices might spark deflation.

ITEM’s research, which analyses how varying oil price scenarios will impact on different economic indicators, suggests that $30 a barrel oil prices would benefit manufacturing output growth by 0.6% and 1.2% this year and in 2010.

But declining revenues for oil companies, plunging worldwide food and oil prices combined with the UK’s recent cut in VAT could drag inflation lower.

Hetal Mehta, senior economist at the Ernst & Young ITEM Club, said: “Next month’s CPI inflation figures should show a much steeper drop, particularly on the RPI measure as the VAT reduction and larger interest rate cuts feed through.

“By later in the year, RPI inflation will be in negative territory and the CPI measure will almost certainly undershoot the 1% threshold. It is very possible that a further fall in the international oil price will spark deflation that will further damage a global economy that is already stumbling into 2009.”