Has inflation peaked?

23 March 2010

The headline rate of inflation fell sharply last month for the first time since September - raising hopes that inflation may have peaked.

Utility price cuts and a slower rise in food prices helped to send the Consumer Prices Index (CPI) - the official measure of inflation - down to 3% in February.

This follows it soaring to a 14-month high of 3.5% in January - well above the Bank of England’s 2% target.

There have been fears that measures such as quantitative easing (the creation of new money) and the record-low interest rate could cause a spike in inflation. But economists now say the larger-than-expected fall in February should help to bring some comfort that underlying prices in the UK economy remain pretty subdued.

While the VAT reversal, increasing commodity prices and the sterling depreciation are stimulating inflation, most economists believe it will fall in the coming months.

Jonathan Loynes, chief European economist at Capital Economics, predicts that while inflation is likely to hover at current levels for the next few months, it should fall back “sharply” later this year and in 2011.

As such, he says the Bank of England may keep the interest rate low for some time.

Howard Archer, chief UK economist at IHS Global Insight, also believes that while CPI could rise further in the short term, it will fall to under 2% by the end of the year.

“Given that oil prices bottomed out early in 2009 and then firmed, base effects will become more favourable,” he explains.

“Meanwhile, underlying price pressures should be contained by substantial excess capacity, likely bumpy and gradual recovery, wage moderation amid high unemployment and job insecurity, and the need for retailers to price competitively in the face of still limited consumer spending.”
Despite the fall in CPI, savers are still suffering from the erosive impact inflation has.

A basic-rate taxpayer needs to find an account paying 3.75%, while a higher-rate taxpayer needs to find an account paying 4.98%, in order to beat inflation.
Michelle Slade, spokesperson for Moneyfacts, says: “ Despite the fall, inflation continues to erode the value of savers’ money and with rates also declining, savers are being dealt a double blow.
“Prudent savers are being neglected and are finding it virtually impossible to combat the effects of tax and inflation.”

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