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Last Updated: Tuesday, 14 August 2007, 15:10 GMT 16:10 UK
Inflation falls on food price war
Basket of food
The fall could prompt the Bank of England to halt rate rises
Weaker food prices helped the UK's rate of inflation to fall below analysts' forecasts to 1.9% in July.

Consumer Prices Index (CPI) inflation dropped sharply from June's level of 2.4%, raising hopes that further rises in interest rates will not be needed.

It is the first time UK inflation has fallen below the government's target of 2% since March last year.

Retail Prices Index inflation, a measure often used in pay bargaining, fell to 3.8% in July from 4.4% in June.

"This is a massive surprise," said Howard Archer, chief UK and European economist at Global Insight.

"Consumer price inflation fell back far more than anyone was expecting in July, including, we strongly suspect, the Bank of England.

"This will boost expectations that interest rates have peaked at 5.75%, especially as the current turmoil in global credit and financial markets further dilutes the case for higher interest rates, for now at least."

Interest rate peak?

The inflation figures come on the same day as a report from the Royal Institution of Chartered Surveyors (RICS), indicating that the number of people looking to buy a house for the first time fell at its fastest rate in three years.

The fact that CPI has come in well below their expectations must put some question mark over a move to 6% interest rates
Ian Kernohan, Royal London Asset Management

The Bank of England has raised UK interest rates five times since August last year. It suggested last week in its Quarterly Inflation Report that one more rise would be needed to rein in inflation.

But the greater-than-expected drop in the monthly figure prompted currency speculators to consider the possibility that the Bank's Monetary Policy Committee (MPC) could now halt rates at 5.75%, or at least push back the timing of any rise.

This triggered a sell-off in sterling, which dipped below the $2 level after the inflation figures were released. However, the pound subsequently regained some strength to hover around the $2 mark.

Higher interest rates are attractive to currency investors, who will buy into currencies that provide a higher income.

"Although the MPC focuses on future inflation rather than today's rate, the fact that CPI has come in well below their expectations must put some question mark over a move to 6% interest rates," observed Ian Kernohan, an economist at Royal London Asset Management.

Flood costs

The lower cost of food - from bread and cereals to meat, fish and fruit - was the biggest contributor to the surprise fall in consumer price inflation as supermarkets slashed prices to compete for market share in a tough trading environment.

Consumers and homeowners have been increasingly tightening their purse strings as the cost of borrowing has become more expensive.

Heavy discounting by furniture retailers seeking to attract customers into stores during the wettest July on record also helped push inflation below the government's key 2% target, as did lower energy bills.

But the Office for National Statistics cautioned that the heavy summer rain across the UK could cause supermarket shortages in the run-up to Christmas, which would in turn push up the prices of food, particularly vegetables and milk.

"Food prices look set to rebound sharply due to flooding, while the Bank of England continues to believe that corporate pricing power remains firm," said James Knightley, an economist at ING.

"Overall, though, coupled with the recent market volatility, our September rate hike view looks a lot less likely."

The ups and downs of UK inflation figures

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