Consumer inflation falls to 4.5%

Shoppers at a supermarket have been giving their reaction

Official figures show that UK inflation fell in October from a 16-year high, as oil and transport costs - as well as food prices - fell.

The Consumer Prices Index (CPI) measure dropped to 4.5% from 5.2% in September.

The Office for National Statistics says the month-on-month fall in the CPI figure is the biggest drop in 16 years.

The Retail Prices Index, (RPI) the alternative measure of inflation, which includes housing costs, fell from 5% to 4.2%, the biggest fall since 2003.

See how inflation has changed

The RPI measure is sometimes referred to as the "headline" rate of inflation, and is often used for agreeing pay settlements, or calculating the uprating of benefits such as pensions.

Meanwhile, core inflation, which excludes volatile items such as energy, food, alcohol and tobacco, fell from the series high of 2.2% in September to 1.9%.

Food prices fall

The CPI fall was the biggest since August last year.

"The largest downward pressure on the CPI annual rate came from transport costs where the price of fuels and lubricants fell this year but rose last year," said the ONS.

Deflation would have appalling consequences for British business and for the economy as a whole David Kern, British Chambers of Commerce Calculate your personal inflation Deflationary dangers

"The decrease this year was triggered by a sharp fall in the price of crude oil."

There was also a fall in the price of both air transport and sea transport.

There was another large downward contribution from food and non-alcoholic beverages, with meat prices being cut by supermarkets.

Key interest rates

The Bank of England has said inflation could fall below its target of 2% next year - and might drop as low as 1%.

This year, the UK economy shrank for the first time since 1992 - falling by 0.5% in the third quarter of 2008.

This led the Bank of England to lower its key Bank Rate in October by 1.5 percentage points - to 3% from 4.5% - its lowest level since 1955.

With commodity prices falling and the economy shrinking fast, inflation is going to undershoot the 2% target by the middle of next year Hetal Mehta, Ernst & Young Item Club

David Kern, chief economist at the British Chambers of Commerce, said: "Following these [inflation] figures, it is clear that UK interest rates will be cut further, most likely to 2% in early 2009.

"One cannot rule out rate cuts below 2% later next year."

The impact of the rapidly-slowing UK economy is pulling down cost-of-living increases thanks to falling food and fuel prices - the latter helped by crude oil prices remaining under $60 a barrel.

Hetal Mehta, senior economic advisor to the Ernst & Young ITEM Club, said: "With commodity prices falling and the economy shrinking fast, inflation is going to undershoot the 2% target by the middle of next year.

"And while it is still unlikely on the CPI measure, the prospect of deflation cannot be ruled out."

Deflation 'likely'

Figures from the Office for National Statistics, show that output prices - the price of goods leaving the factory - dropped by 1% in October.

Input prices - the cost of raw materials purchased by the manufacturers - dropped by 5.6% in October, the biggest drop since 1986.

Mervyn King, the Governor of the Bank of England, says it is now "very likely'' that the UK's retail price index will turn negative next year.

The Bank is expected to cut rates again in December, say economists, perhaps by a full percentage point to 2%, a level not seen since the 1930s.

Downward spiral?

A short period of deflation - where prices fall rather than rise - would not be a disaster, but a longer period of falling prices might be, say economists.

In prolonged periods of deflation, consumers hold off buying goods, reckoning they will be cheaper later on, according to economic theory.

This can lead to further falls in demand and output. As firms sell less, they respond by cutting jobs or cutting wages.

Overall, consumers then have less money to spend - and demand falls yet again.

"The possibility of deflation at that time is now a distinct risk," said the BCC's Mr Kern.

"Deflation would have appalling consequences for British business and for the economy as a whole so it is imperative that the government and Bank monetary policy committee take forceful action."

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