Sharp fall in cost of living

Shoppers at Sainsbury's

The official measure of the cost of living fell sharply in April, mainly as a result of cheaper energy bills and food prices.

The Consumer Prices Index (CPI) fell to 2.3% in April, down from 2.9% the previous month. CPI, which the Bank of England uses as its official measure of inflation to determine base rate movements, peaked last September at 5.2% but has been falling since then back towards its 2% target.

Meanwhile, the Retail Prices Index (RPI) – which unlike CPI includes housing costs such as mortgage interest payments – also experienced a dramatic fall during April; it turned negative last in March, but has now fallen further to -1.2%.

This is the lowest figure since records began in 1948. The Office for National Statistics, which compiles the inflation figures, says cheaper mortgage rates, combined with house price falls, and lower council tax rates compared with last year, contributed to the sharp fall. Home contents insurance premiums have also fallen in price. 

The falls seen across both measures during April suggest that the UK is still heading towards a period of deflation, where prices fall rather than rise. If this happens, then the Bank of England is likely to maintain the base rate at its current level of just 0.5% for some time.

The central bank increases the base rate when inflation rises, in order to calm consumer demand and make borrowing more expensive.

Jonathan Loynes, chief European economist at Capital Economics, says: “April’s figures confirm that price pressures in the UK economy are still fading fast.”

He forecasts that the economic downturn means CPI could also turn negative in the months ahead: “Overall, a reminder that excessively low inflation, or deflation, is still a bigger risk over the next few years than a rapid rise in inflation.”

However, some economists do not expect CPI to turn negative - and believe that it could rise early in 2010.

Phillip Shaw, economist at Investec Securities, explains: "CPI inflation looks set to continue to fall sharply and we expect it to bottom out at close to 0.5% during the autumn.

"Thereafter the planned return of VAT to 17.5% from 15% in January 2010 will push inflation up above 2% for a while, although given that not all of last year’s reduction was passed through, it is reasonable to suppose that the upside may also be constrained."

However, Shaw adds that inflation should still remain below its 2% target throughout most of 2010 and 2011.