Cheaper food helps drive inflation down

Tesco Metro store

The rate of inflation fell to its lowest level for more than four-and-a-half years in August amid a dip in food prices and lower utility bills.

The Consumer Prices Index (CPI), the official measure of the cost of living, dropped to 1.6% last month, its lowest level since January 2005. This is down from 1.8% in July and well below the Bank of England’s 2% inflation target.

Economists were expecting the rate of inflation to rise during the month; they attribute the surprise fall to the rise in oil prices and the increasing cost of second-hand cars. The largest downward effect on CPI came from gas, followed by food.

In contrast, the Retail Prices Index (RPI), which includes mortgage repayments, improved slightly from -1.4% in July to -1.3%.

Economists expect that the cost of living will fall further in September before picking up slightly again next year amid higher petrol prices and the return of VAT to its 17.5% level.

Howard Archer, economist at IHS Global Insight, says CPI could fall close to 1% in September. However, he adds: “This will probably prove to be the floor as inflation will come under upward pressure from the final months of this year from unfavourable base effects.”

But Vicky Redwood, UK economist at Capital Economics, believes the rate of inflation will stay low for some time. "The big picture is still that inflation is set to fall to very low levels next year and beyond – with a prolonged period of deflation still the main risk,” she says.