Page last updated at 14:26 GMT, Tuesday, 14 October 2008 15:26 UK

Where now for UK inflation?

By Hugh Pym
Economics editor, BBC News

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Recessions have a habit of pulling down prices

The annual inflation rate - up from 4.7% to 5.2%. It sounds a grim headline, and to an extent it is. So why is everybody talking about inflation falling rapidly?

And why on earth did the Bank of England cut interest rates by half a percentage point last week if they suspected this big inflation increase was just round the corner?

We are in a bizarre world where there is a big story which we know won't be a story for very much longer.

Swingeing increases in gas and electricity bills were largely to blame for the acceleration in the cost of living in September.

Gas prices are nearly 50% higher than a year ago and electricity prices are up more than 30%.

But we knew that would happen. So too did the Bank of England, which has been predicting for a while that inflation would get above 5% at some stage.

Cheaper food

But in some areas it was a different story.

Food inflation slowed in September. Prices of bread, cereals, milk, cheese and eggs were among those items which fell in the month. Wheat prices have fallen dramatically in the last few months.

The great inflation of 2008 could become no more than a footnote in the history of the early 21st century

It's possible that the great surge in food prices, which put so much pressure on household bills this year, is petering out.

Oil prices have come down as rapidly as other commodities. Only a few months ago they were above $140 a barrel. In recent days they have been below $80.

Some of the breathtaking increase this year can be blamed on the rush of speculative cash into commodities. Investors may well be bailing out and taking profits. But the oil markets have recognised a fundamental truth - in a recession demand for oil falls through the floor.

Change in focus

Recession in leading economies is now the focus of economists, bankers and investors. And that's why the inflation threat is being discounted by most of them.

Recessions have a habit of pulling down prices. Goods and services get cheaper as unemployment rises and consumer spending contracts.

Until a fortnight ago the Bank of England seemed fearful of the consequences of higher inflation. The danger of a wage-price spiral developing preoccupied the Monetary Policy Committee. The chances of an interest rate cut seemed remote until the inflation peak had passed and a downward path over a couple of months could be observed.

But the extraordinary turmoil in the financial markets and the near collapse of some leading banks transformed the outlook.

The Bank of England participated last week in the co-ordinated interest rate cut with other leading central banks. By this stage they were fully focussed on the danger of a severe recession developing from the ruins of the financial markets.

So the great inflation of 2008 could become no more than a footnote in the history of the early 21st century.

It's possible that there won't be any inflation at all by this time next year as the commodity price falls work through the system.

That 5.2% figure could be quickly forgotten - though it may not seem like that to households still struggling with high food and fuel bills.



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