Inflation falls to 3%

17 February 2009
The Office for National Statistics has revealed that the Consumer Prices Index (CPI) - the government’s official measure of inflation - fell to 3% in January, down from 3.1% in December.
Meanwhile, the Retail Prices Index (RPI) - which includes mortgage interest payments - also fell to 0.1% in January, significantly lower than the previous month’s 0.9%. 
Last year, the rising cost of food and fuel pushed inflation to a peak of 5.2% in September, well above the government’s 2% target. 
While food prices are unlikely to come down in the near future, cheaper crude oil (which has fed through to petrol prices and energy bills) means the cost of living is likely to continue to fall in coming months.
Jonathan Loynes, chief European economist at Capital Economics, says the drop in CPI was smaller than expected, with most economists forecasting a reduction of at least 0.3%. He attributes this smaller fall to the rising cost of furniture and household goods, as well as recreation.

However, he adds inflation could still fall to zero over the coming months: “We suspect that this is a temporary aberration reflecting the partial reversal of some very aggressive price discounting in December.”
Last week, the Bank of England predicted that the UK would only narrowly avoid a negative inflation rate - or deflation - over the next two years. Its quarterly inflation forecast estimated CPI would reach a low of just 0.5% in two years time.
"The broad picture is for inflation to continue to run well below [the government’s 2%] target," deputy governor of the central bank Charles Bean told the National Farmers' Union in Birmingham yesterday.
"The Bank's monetary policy committee (MPC) will probably need to take further action to return inflation to the target in the medium term," he said. "That is a discussion we will no doubt have at future meetings."
His comments were taken as a green light that interest rates, which were cut from 1.5% to 1% earlier this month will have to fall again when the next decision is made by the MPC on 5 March. 
However, because interest rates cannot fall below zero, Bean acknowledged that the MPC is running out of options. "If interest rates remain where they are, the recent cuts will continue to provide a building boost to demand through this year and beyond - but we don’t have to keep on cutting rates in order to provide a stimulus."
Analysts believe that the Bank could now begin a process of quantative easing - or printing more money - to spur the economy and avoid deflation.
However Howard Archer, chief UK and European economist at IHS Global Insight, believes that CPI would turn negative for a while in the second half of this year, averaging 0.8% over the year as a whole.

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