The prospect of deflation in the economy appears to be a real possibility in the near future as inflation drops dramatically, spelling good news for pensioners.

With the latest Retail Prices Index (RPI) showing a drop in inflation to 0.9 per cent, Matthew Furnis, senior consultant at Punter Southall, believes that the prospect of deflation in the economy in the near future could be a real possibility.

He says, ‘Deflation is clearly of concern to the UK economy as a whole but, surprisingly, can actually impact pensioners favourably thanks to their spending habits and the way that both company and state pensions are calculated.’

The Basic State Pension (BSP) is increased each April in line with the preceding September RPI annual inflation and hence for a single pensioner, the BSP will increase by five per cent in April 2009, the biggest rise since 2001. The government has also recently ensured that the BSP will increase by a minimum of 2.5 per cent each year, which will safeguard any future increases from deflation.  

Company pensions are also protected from deflation as they cannot normally be reduced and a proportion of pensions are increased by fixed percentages, normally between 2.5 per cent and five per cent per year.  

Furnis points out that, over the past year, inflation has been a real problem particularly for pensioners who are impacted far more by rising energy and food prices, the main causes of last year’s inflation, than the rest of the population, due to the proportion of their income spent on these items.  

He adds, ‘As prices go up, they can also go down. Driven largely by the dramatic collapse in oil prices and fall in demand following the credit crunch, prices appear to have started to fall.

‘Although pensioners were the worst hit from recent inflation, they are, for the same reasons and to a similar extent, those most likely to benefit from falling prices, particularly in energy.’