UK inflation falls sharply

According to the Office for National Statistics (ONS), UK inflation has fallen from its 16-year high of 5.2% in September down to 4.5%, as energy costs and oil prices have fallen.

The fall was much more than economists had expected and will now pave the way for further aggressive interest rate cuts, following a cut of 1.5% to 3% earlier this month.

The ONS said the drop in inflation is the biggest month-on-month fall since 1992.

Inflation has been spiralling above the Bank of England’s target of 2% but could now fall as low as 1%. Yesterday, Prime Minister Gordon Brown told the House of Commons that next year the problem is deflation and the problem of inflation close to zero.

Meanwhile, figures from the ONS said the Retail Prices Index, (RPI) the alternative measure of inflation, which includes housing costs, fell to 4.2% from 5%, the largest fall in five years.

Core inflation, which excludes volatile energy and food prices, food, alcohol and tobacco, fell from 2.2% to 1.9%, suggesting that retailers are slashing prices in an bid to tempt customers into the shops.

According to David Kern at the British Chambers of Commerce, the figures from the ONS will undoubtedly result in the Bank of England making further cuts in interest rates, most likely to 2% in early 2009. However, rate cuts below 2% later next year cannot be ruled out, said Mr Kern.

Meanwhile, Hetal Mehta, senior economic advisor to the Ernst & Young ITEM Club, said inflation could fall below the 2% target in mid-2009 as commodity prices continue to fall and the economy shrinking fast.

According to economists, a short period of deflation (where prices fall rather than increase) would not be a disaster, however, a long period of deflation would be a serious threat to the economy because it deters consumers and businesses from spending in expectation of falling prices.

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