Expert Panel: Deflation question

The Bank of England has revealed it expects inflation to become deflation later this year. Some commentators have warned of the dangers while others have suggested a short-lived dose of deflation will be good for the country. In December UK inflation was reported at 0.5%. That is expected to drop again when January figures are reported.
Room151 commentators* offer their view of UK deflation for local government.

Mark Carney, governor of the Bank of England

Frank Wilson

I’m not too sure what all the fuss is about. For councils with reserves low inflation means reduced investment returns but then low cost inflation should offset this loss.

Multi-year pay freezes when inflation was running at around 3% had a severe effect on real local government pay, and this is now starting to bring its own problems with recruitment and retention issues in some services.

Should inflation stay around the 1% mark then further pay restraint should avoid leading to a further deterioration in real pay. I think I would be more concerned if inflation was running at 4% again as there would be no way a government would allow public sector pay to keep pace.

In revenue generation terms can cuts in real council tax income be reversed? I think that more likely in a low inflation environment than high inflation environment. For those levying a 2% rise this year then at least it is a real terms increase.

Trevor Casteldine
Long-term low inflation means a degree of predictability of costs, meaning that hopefully budgeting will be more stable. However, when overall budgets stay constant, reallocation of priorities are hard to hide.

Choosing between the different demands on the treasurer’s funds will have to be explicit and well-explained. More bravery will be needed by all involved. Another problem with long-term low inflation is that it is likely to mean low long-term interest rates, so the 2016 actuarial valuation of pension liabilities will be shocking.

That could impact amounts needed to be collected from admitted bodies significantly, possibly catastrophically. And a low-inflation-low growth environment could mean that unless managed imaginatively, pension fund assets won’t be able to grow themselves out of the problem.

Stephen Fitzgerald
The debate on economics tends to be cast in a negative light. The good thing about low inflation for local government is that baseline cost increases for goods and services are constrained.

In an environment where central government contributions to local government are falling and council taxes are all

but frozen, an inflationary situation could prove crippling. However, every day of the year local authorities have large amounts of money held in cash deposits.

With low inflation and low interest rates, risk-free rates of return are low, which is making it difficult for treasury managers to achieve significant income from liquid cash. Linked to understandable risk aversion, following the cataclysmic Icelandic banking collapse and the fall in the rating of many financial institutions, local authorities have limited scope for the placing of deposits.

The challenge is for innovative treasury managers to seek better returns. Money market funds can present a viable alternative to cash deposits as do bonds. But it is important to know the risks thoroughly. Expert advice is an essential investment.

*Frank Wilson is strategic director for resources at West Oxfordshire District Council and Cotswold District Council.

Trevor Castledine is head of investment at Lancashire County Pension Fund, one of the largest of its kind in the UK.

Stephen Fitzgerald is a management and financial consultant working in the local authority sector.