"Fears of deflation are not what they were
Today's inflation figures confirm that it's not time to start worrying about inflation yet. But the subtext of last week's Inflation Report from the Bank of England [2.6Mb PDF] was that fears of deflation are not what they were.
As Liam Halligan has pointed out, the word "deflation" doesn't feature once in this latest Inflation Report. Looking back to the February report [2.9Mb PDF], I can find around half a dozen references, and a detailed explanation of what deflation could mean for the economy.
Of course, it was precisely that fear which led the Monetary Policy Committee to start its policy of quantitative easing (QE) the following month.
As Mervyn King emphasised in last week's press conference, the Bank thinks that it's too soon to judge the impact of that policy. But it clearly thinks that the combination of rate cuts and QE has helped to lower the risk of a sustained period of falling prices.
According to the latest Report, the MPC now thinks "there are significant risks to the inflation outlook in each direction". In February, it thought the the balance of risks "were slightly on the downside".
You can overdo the shift in the Bank's thinking. Remember how the governor went on (and on) about the degree of uncertainty.
Still, three months ago, it thought there was a less than 10% chance that CPI inflation would be above target in two years' time. Now (see Chart 5.7, p48) it thinks there's a roughly 20% chance of that happening, while the risk that inflation will be negative in two years' time has fallen, from about 1 in 4, to 1 in 10.
As I said when I first raised this point a few weeks ago, it's a long way from here to worrying about inflation. But, at the very least, the new forecasts suggest that there's less room for the economy to grow rapidly after 2010, without raising inflation, than we might have hoped.
It's also a reminder of the very fine line the Bank will be walking, if and when a self-sustaining recovery does arrive.
Mervyn King's fairly downbeat assessment of the economy last week helped to douse city speculation about how and when QE would be put into reverse.
However, the implication of the Bank's own report is that even with a fairly weak recovery, the MPC will be grappling with those questions sooner than you might think.
This is particularly important when one considers the UK's somewhat mixed standing in international markets.
Last week's grim economic news from the Eurozone economies reminded us that the UK has a big advantage in this crisis which those countries lack - the ability to print our own money (or to create it electronically, as we must learn to say).
As long as it doesn't cause inflation, QE should help boost demand and lessen the cost of the recession. But, as Mervyn King admitted last week, one of its direct - indeed, less intended - effects ought to be to push down the currency.
That is bad news for any foreigner sitting on British assets. The Bank can't afford to scare investors even more with the suggestion that it is relaxed about the government inflating away its debt.
Now, as it happens, sterling has gone up since QE began (and it rose again today). It just shows that the currency markets never do what they're supposed to do - though the pound is still far below where it was last summer.
The Bank's policy is only one factor affecting sterling. And if it's bringing the recovery closer, a lot of investors will consider that a plus for the pound.
Be in no doubt - if there is now a smaller risk of a long period of falling prices, that is extremely good news. With our high level of public and private debt, deflation would be a worse disaster for the UK than for almost any other major economy.
But we might pay a heavy price if investors start to think that the Bank is taking us too far the other way. "