Deflation looms as prices fall

16 December 2008

The cost of living has fallen for another month, with inflation at 4.1% in November down from 4.5% in October.

The Consumer Prices Index (CPI) – the official measure of inflation – peaked in September at 5.2%. Cheaper crude oil and commodity prices have helped it fall back down towards the government's 2% target, with cheaper transport having a particularly large impact during November.

The average price of petrol fell by 9.3p per litre between October and November this year, to stand at 95.2p, compared with a rise of 3.5p last year. Diesel prices fell by 7.5p per litre this year compared with a rise of 5p last year.

There was also a fall in the price of second-hand cars compared with a rise a year ago.

However, economists had been expecting CPI to slow to 3.9% in November as a result of the 2.5% VAT cut.

The Office for National Statistics says inflation would have fallen further if it hadn’t been for price rises in the food and non-alcoholic beverages sectors. The cost of recreation and culture is also up over the past year.

Meanwhile, the Retail Prices Index (RPI) – which includes mortgage payments – slowed to 3% in November, down from 4.2% in October.

Jonathan Loynes, chief European economist at Capital Economics, says the fall in CPI means the UK is still on track to enter a period of deflation (the first for more than half a century) next year.

He adds: "Admittedly, the fall in the headline inflation rate from October’s 4.5% to 4.1% was rather smaller than expected. But [the rise in food costs and cheaper petrol] won’t prevent inflation falling much further over the coming months.

"We still expect CPI inflation to turn negative next summer, with RPI inflation dropping even further thanks to the extra downward pressure from house prices and mortgage payments."

Arek Ohanissian, economist at the Centre for Economic Business Research, agrees that the fall reinforces concerns that falling inflation will lead to a deflationary spiral.

"It remains to be seen if consumers will eventually expect deflation and correspondingly delay purchases in hopes of lower prices," he adds. "In the meantime, the falling inflation rate allows the Bank of England greater scope to lower the base rate to record lows."

Ohanissian warns that one consequence of significant cuts will be further devaluation of sterling.

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