INFLATION is on course to plunge below 1% next year as the UK economy slides into recession, Bank of England Governor Mervyn King signalled yesterday.
In a letter to the Chancellor to explain why inflation had risen so far above its 2% target, Mr King also revealed there could be more help to get banks lending again to households and businesses.
The latest dialogue with the Treasury was penned after official figures revealed the annual rate of UK inflation stood at 4.1% in November, down from 4.5% in October, but still above the 3.1% level that triggers a quarterly letter of explanation from the Governor.
But, while inflation remains more than double the target, CPI has been falling since October as a looming recession has brought oil prices tumbling down and reined in firms’ pricing power.
Mr King said it was “quite possible” that his next letter to the Chancellor would be to explain why inflation had fallen more than 1% below the Bank’s 2% goal.
The Governor’s hints of measures to free-up the UK lending drought will spark speculation over a potential package of so-called “quantitative easing” – pumping more money into the economy to spur on lending.
The Treasury last night announced it would lower the cost of fees for banks using its £250bn credit guarantee scheme under plans to jump-start the lending market.
It is thought that, as well as quantitative easing, the Government may be looking at introducing guarantees for interbank lending to kick-start wholesale money markets.
Yesterday’s fall in the Consumer Prices Index (CPI) official measure of inflation saw inflation fall to its lowest level since June, although it was higher than the 3.9% figure expected by economists.
The figures from the Office for National Statistics (ONS) showed that tumbling fuel inflation – which saw its largest decline since records began in 1997 – helped bring CPI down for the second month in a row.
The easing in oil prices saw the average price of petrol in the UK fall by 9.3p a litre between October and November, to 95.2p a litre.
However, the ONS data also showed that food inflation continued to put upward pressure on CPI last month, with fresh fruit and vegetables more expensive than a year ago.
Meanwhile, hefty drops in house prices and the Bank of England’s 1.5% cut in interest rates last month helped bring Retail Prices Index (RPI) inflation down to its lowest level since April, 2006.
RPI, which includes mortgage interest payments, dropped to 3% in November from 4.2% the previous month – the fastest decline for more than 17 years.
The impending UK recession and the Government’s reduction in VAT to 15% earlier this month is set to bring both CPI and RPI inflation down even further.
The VAT changes could delay December inflation figures by up to two weeks as it impacts on pricing calculations, according to the ONS.
Experts are now predicting months of negative inflation next year, although many do not believe the UK will suffer a period of sustained deflation.
There are reportedly concerns that the weakness of the pound may prevent the Bank from cutting rates as fast as they would like.
The performance of the pound has been hit hard as inflation expectations have plunged, with sterling falling to new record lows against the pound this week.
JP Morgan Chase economist Malcolm Barr stuck by predictions for a further 0.5% rate cut in January – to 2.5% – despite the currency concerns and higher than forecast November CPI data.
Liberal Democrat Treasury spokesman Vince Cable said: “These figures do suggest that, at a time when we’re heading into a painful recession, many people are still seeing their living standards falling, because of the cost of living.”
