Consumer inflation down in May

15 June 2010

UK consumer price inflation fell slightly faster than expected in May, boosting hopes that April's 17-month high marked a peak.

The Office for National Statistics said that the annual rate of CPI inflation fell to 3.4% in May from 3.7% in April.

This is a slight improvement on the fall to 3.5% forecast by economists.

Falling food prices – particularly those for meat and fruit - prompted the fall as well as the slower rises in the cost of petrol, alcohol and tobacco compared to the same month last year.

On the month, consumer price inflation rose by 0.2%, a third of the 0.6% rate recorded in April and less than the 0.3% increase expected by analysts. 

The retail price inflation gauge, used as a basis for some wage deals, fell to 5.1% on the year from 5.3%, versus forecasts for an easing to 5%. 

The core rate of CPI, which excludes volatile food and energy costs, also fell to its lowest rate since February at 2.9% on the year. 

The figures are good news for the Bank of England. Last month it had to write a public letter explaining why inflation had remained so far above its 2% target for such a long time.

The Bank is hoping that the continued upward CPI inflationary pressure from domestic electricity bills and housing will soon abate.

“Inflation should head down further over the coming months as recent temporary upward pressures increasingly unwind,” says Howard Archer, Chief UK and European Economist at IHS Global Insight.

“Given that oil prices bottomed out in the first quarter of 2010 and then firmed, oil-price related base effects should become more favourable barring a renewed sharp rise in oil prices over the coming months. Indeed, oil prices have been softer recently. In addition, the pound's past sharp depreciation should now have largely finished feeding through to push up prices,” he comments. 

Of course the optimism may be drowned out by a VAT hike in Chancellor George Osborne's first Budget next Tuesday. Howard agrees: “If, as seems likely, VAT is increased from 17.5% to 20% - either at next week's emergency budget or sometime over the coming months - as part of the government's measures to rein in the public finances, this will have a temporary upward impact on inflation.”

If the VAT increase does not materialise then inflation is expected to head down significantly in the coming months and be back within the Bank’s 2% target by early 2011. However, if the heat does not come out of inflation then all eyes will be on interest rates with expectations of a small rise before the end of this year. 

Jonathan Loynes, Chief European Economist at Capital Economics remains optimistic: “This process should have plenty further to go over the coming months and, coupled with the effects of the large amount of spare capacity in the economy, should help core inflation to fall considerably further.”

He adds: “Overall, inflation worries are not about to disappear overnight. But there is some reassurance here that the Monetary Policy Committee will be able to avoid the nightmare scenario of having to raise interest rates alongside the huge fiscal squeeze.”


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