What does the fall in inflation mean for the economy?
Inflation was primarily reduced in April by lower petrol prices and lower air fares helped by Easter falling in March in 2013. In addition, core inflation retreated to a 41-month low of just 2%. The only significant upward impact on inflation came from higher food prices.
This was the first time that inflation had fallen back since September 2012 and gives incoming Bank of England governor Mark Carney greater scope for manoeuvre on monetary policy.
Even so, CPI of 2.4% in April is still putting an appreciable squeeze on households' purchasing power given that average weekly earnings actually fell 0.7% year-on-year in March and were up a mere 0.4% year-on-year in the three months to March.
"The downward move in CPI inflation is clearly welcome, particularly for households with pay growth having dropped to its lowest level since records began in March 2000," point out analysts at Investec.
What does this mean for monetary policy?
The easing of upside inflation risks facilitates further monetary stimulus by the Bank of England, should recent signs of improving economic activity falter or if the Monetary Policy Committee (MPC) feel that the economy could do with some extra fuel to try and build momentum.
Howard Archer, chief UK and European economist at IHS Global Insight, suspects the Bank of England will go for more quantitative easing once Mark Carney takes over as governor in July.
"We suspect that Mr Carney will be keen to try and build up escape velocity from the economy's extended softness and will be keen to establish his presence," he says. "Of course, Carney will only have one vote out of nine in the MPC as does Sir Mervyn King, but we suspect that he will be able to carry a majority of MPC members with him should he favour more help for the economy."
He adds: 'It also seems highly probable that the Bank of England under Carney will adopt the policy of giving guidance on the likely future path of interest rates.
"We do not expect the Bank of England to take interest rates below 0.5%."
What does this mean for stockmarkets?
"Such a big drop in inflation has hit the City like a double espresso shot, sending UK equities deeper into what we feel is overvalued territory," states Jamie Perkins, partner at the IFA Westminster Wealth Management.
"Inflation's growth-throttling squeeze on the economy has slackened substantially, but the stockmarkets' bull run should not be confused with real progress."
Archer acknowledges that CPI may move back up over the next few months, but stresses that it may not even reach 3% over the summer rather than going as high as 3.5% as had seemed likely earlier this year.
"Critically, underlying price pressures should be contained over the coming months by significant excess capacity, further moderate wage growth amid appreciable labour market slack, and limited scope for retailers to rise prices given still significant pressures on consumers," he comments.
Specifically, Archer is forecasting CPI inflation to stand at 2.7% at the end of 2013 and then trend down gradually to stand at 2.1% at the end of 2014. "There is a very real chance that inflation could finally get down to the promised land of 2.0% early in 2015," he adds.
This article was written for our sister website Interactive Investor
Monetary Policy Committee
A committee designated by the Bank of England to regulate interest rates for the UK. The MPC attempts to keep the economy stable, and maintain the inflation target set by the government and aims to set rates with a view to keeping inflation at a certain level, and avoiding deflation. The MPC meets on the first Thursday of each month and discusses a variety of economics issues and constitutes nine members: the governor, the two deputy governors, the Bank’s chief economist, the executive director for markets and four external members appointed directly by the Chancellor.
Lower interest rates encourage people to spend, not save. But when interest rates can go no lower and there is a sharp drop in consumer and business spending, a central bank’s only option to stimulate demand is to pump money into the economy directly. This is quantitative easing. The Bank of England purchases assets (usually government bonds, or gilts) from private sector businesses such as insurance companies, banks and pension funds financed by new money the Bank creates electronically (it doesn’t physically print the banknotes). The sellers use the money to switch into other assets, such as shares or corporate bonds or else use it to lend to consumers and businesses, which pushes up demand and stimulates the economy.
A financial adviser who is not tied to any financial services company (such as a bank or insurance company) and is authorised by the Financial Services Authority (FSA). They can advise on financial products to suit your circumstances. All IFAs have to give consumers the choice of paying by fees or commission and have to explain which would best suit the customer in that particular instance. Also, if commission is paid either by the client or the financial service provider recommended by the IFA, the IFA must disclose what that commission is.
This is more usually a feature of car insurance but it can also crop up in contents, mobile phone and pet insurance policies. An excess is the amount of money you have to pay before the insurance company starts paying out. The excess makes up the first part of a claim, so if your excess is £100 and your claim is for £500, you would pay the first £100 and the insurer the remaining £400. Many online insures let you set your own excess, but the lower the excess, the more expensive the premium will be.
An interchangeable term for shares (UK) or stocks (US). Holders of equity shares in a company are entitled to the earnings and assets of a company after all the prior charges and demands on the company’s capital (chiefly its debts and liabilities) have been settled. To have equity in any asset is to own a piece of it, so holders of shares in a company effectively own a piece proportionate to the number of shares they hold. (See also Shares).
The Consumer Price Index is the official measure of inflation adopted by the government to set its target. When commentators refer to changes in inflation, they’re actually referring to the CPI. In the June 2010 Budget, Chancellor announced the government’s intention to also use the CPI for the price indexation of benefits, tax credits and public sector pensions from April 2011. (See also Retail Prices Index).
An increase in the general level of prices that persists over a period of time. The inflation rate is a measure of the average change over a period, usually 12 months. If inflation is up 4%, this means the price of products and services is 4% higher than a year earlier, requiring we spend and extra 4% to buy the same things we bought 12 months ago and that any savings and investments must generate 4% (after any taxes) to keep pace with inflation. Since 2003, the Bank of England has used the consumer prices index (CPI) as its official measure of inflation (see also retail prices index).