UK Inflation falls - and hits target

Wednesday 15 January 2014

Inflation fell to the Bank of England's 2% target for the first time in more than four years in December, easing pressure on policymakers to put up interest rates and loosening the squeeze on household finances.

It is the sixth month in a row that the Consumer Prices Index (CPI) rate has fallen, after reaching 2.9% in June. Inflation was last lower, at 1.9%, in November 2009 and since then had risen as high as 5.2%, in September 2011. The latest RPI figures in Jersey are to be released later this week.

Economists expect it will continue to fall during 2014, leaving it on course to be overtaken by wage growth, which has been lagging behind the rise in the cost of living.

The continued decline has helped Bank of England governor Mark Carney enjoy a benign spell during his first six months since taking office in July.

Low inflation saves the Bank's policymakers from being forced to consider raising interest rates from their historic low of 0.5%.

An easing-off in household budget pressures also represents a political bonus for the coalition. Prime Minister David Cameron tweeted: "It's welcome news that inflation is down and on target."

Labour's Treasury spokeswoman Catherine McKinnell welcomed the fall but said: "With prices still rising more than twice as fast as wages, the cost-of-living crisis continues."

The most recent figures showed wages were increasing by just 0.9% a year - meaning they continued to fall in real terms - but it is hoped that a strengthening labour market will see pay rises finally overtake inflation.

Analysts at Capital Economics now forecast CPI easing gradually to 1.5% by the end of the year.

Today's inflation figure from the Office for National Statistics beat expectations for a small rise from November's 2.1% figure, which was already at a four-year low.

Some of the steep increases in gas and electricity tariffs expected to push the rate up did have an upward impact, though not all of them had taken effect by the time data was collected.

These were offset by a slowdown in the rise in the cost of food and non-alcoholic beverages to 1.9%, its lowest level since May 2010, with the main downward contribution coming from fruit and meat.

Games, toys and hobbies also saw price falls as Christmas approached, with reductions in computer games made for older platforms.

Rising petrol prices had an upward effect on inflation, but the increase in the rate of air fares was lower than in 2012.

James Knightley, of ING Bank, said with producer price pressures easing, and the strong pound making imports cheaper, there was growing optimism of the low inflation trend continuing.

"With the labour market strengthening, we will hopefully see wages start to pick up to the extent that incomes are rising faster than the cost of living," Mr Knightley said.

"This would ease the squeeze on household finances and allow consumer spending to continue growing strongly."

Howard Archer of IHS Global Insight said: "It could well take to mid-2014 before earnings growth finally overtakes consumer price inflation."

Looking ahead, Samuel Tombs, of Capital Economics, said changes to the Government's green levies would see energy prices fall in the spring.

Meanwhile, falls last year in global agricultural commodity prices could see food price inflation ease close to zero, while a fall in import prices due to the stronger pound should begin to be seen in shops midway through this year.

"CPI inflation looks likely to spend more time below the 2% target than above it in 2014, helping real earnings to finally recover," Mr Tombs said.

He added that it would enable the Bank of England to leave interest rates on hold for longer, regardless of whether unemployment falls to the 7% threshold, after which policymakers have said they will consider raising it.

The pound rose on the inflation figures, despite the prospect of a prolonged period of low interest rates, amid optimism that an end to the squeeze on household income will see an improvement in household spending.

John Allan, national chairman of the Federation of Small Businesses, said the fall in inflation to the 2% target was a "welcome relief for hard-pressed households and businesses".

There was a note of caution from Andrew Sentance, senior economic adviser at PwC and a former member of the Bank of England's monetary policy committee.

"Now that inflation has returned to target, the challenge will be to keep it there," he said. "Stronger growth here in the UK could push up wage costs and a rebound in the global economy is likely to push up energy, food and commodity prices once again.

"So we cannot be sure that this return to the inflation target will be sustained through 2014."