Page last updated at 09:40 GMT, Tuesday, 15 September 2009 10:40 UK

UK inflation rate falls to 1.6%

Shop in Dalston, north-east London
Inflation is slowing as firms cut prices to survive

A key measure of inflation has fallen to its lowest level since February 2005, official statistics show.

The Consumer Prices Index (CPI) dropped to an annual rate of 1.6% in August from 1.8% in July.

But the Retail Prices Index (RPI) inflation measure, which includes mortgage interest payments and housing costs, rose, to -1.3% from -1.4%.

The Bank of England aims to maintain inflation at 2% to keep both prices and the broader economy stable.

On Tuesday, the Bank's governor, Mervyn King, told the Treasury Select Committee that inflation was "likely to be volatile" over the next six months, initially falling further below the 2% target, then rising above it.

"That volatility reflects base effects as well as the reversal of last year's VAT cut," he said.

Cheaper food

Lower food costs contributed to the fall in consumer price inflation, with the price of fruit, vegetables, bread and meat all decreasing, said the Office for National Statistics (ONS).

Hugh Pym, BBC chief economics correspondent
We are entering a volatile period for inflation. The Governor of the Bank of England, Mervyn King, said as much at the Treasury Select Committee. He said inflation would fall further, then rise above its 2% target.

This is largely to do with unpredictable elements, such as utility bills and petrol. Big increases one year which are not repeated 12 months later will automatically cause inflation to fall and vice versa.

The fall in the annual rate, as measured by the Consumer Prices Index, from 1.8% to 1.6% in August, should be seen in that context.

The governor said economic growth was set to resume. But it will take some time for growth to get anything like back to its trend rate. So the big picture is that inflation will be subdued for some time.

Gas and electricity prices remained little changed, but transport costs went up, thanks to a rise in the average price of petrol.

British Chambers of Commerce chief economist David Kern said the August inflation figures were "slightly higher than expected".

But he added: "The figures do not alter the basic fact that signs of recovery remain fragile, and the main policy priority is to avoid a setback."

Mr Kern called on the Bank's Monetary Policy Committee to increase its quantitative easing programme to £200bn.

He said it should also consider imposing a negative interest rate on deposits held by banks at the Bank of England.

Vicky Redwood, economist at Capital Economics, said that despite the prospect of higher inflation next year, "the big picture is still that inflation is set to fall to very low levels next year and beyond - with a prolonged period of deflation still the main risk."

Need to explain

If the CPI falls below 1%, the Bank of England governor will have to write a letter of explanation to Chancellor Alistair Darling.

In 2007 and 2008, when inflation topped 3%, Mr King had to write letters to the government because it was overshooting the target. But as far as the Bank is concerned, too little inflation is as bad as too much.

Investec chief economist Philip Shaw said he believed the time for Mr King's next letter could come as early as September.

He said: "We continue to expect inflation to drop below the 1% 'band of tolerance' around the Bank of England's 2% target next month."

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