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Inflation drops to key 2% target level as BoE holds base rates

ANNUAL UK inflation fell back to 2% in December, after four years above this key target level, official figures have revealed.

Inflation has fallen sharply, from 2.9% in June, and the decline to 2% will give the Bank of England further scope to continue to hold UK base rates at their record low of 0.5% to aid economic recovery.

The City had forecast annual UK consumer prices index (CPI) inflation in December would have been unchanged from November, at 2.1%. But the latest figures, published yesterday by the Office for National Statistics, instead showed a third consecutive monthly fall in annual inflation.

December is the first month since November 2009 in which annual UK CPI inflation has not been above the 2% target set by the Treasury for the Bank of England.

Liz Cameron, chief executive of Scottish Chambers of Commerce, said: "The news that inflation has fallen back to its target level for the first time since 2009 is good news for consumers and businesses. The high level of c onsumer demand has been one of the primary drivers of growth in the Scottish economy over the past year, and if this is to be sustained then low levels of inflation will assist greatly."

She added: "This should also ensure that the Bank of England is able to maintain low interest rates for some time to come, even if unemployment falls back below 7% this year."

The Bank's Monetary Policy Committee said last August that it did not intend to raise base rates from their record low of 0.5%, at which they have stood since March 2009, at least until the International Labour Organisation measure of unemployment had fallen to a "threshold" of 7%.

Its forward guidance on rates would cease to hold if, in the MPC's view, it was more likely than not that annual UK CPI inflation 18 to 24 months ahead would be 0.5 percentage points or more above the 2% target. It would also cease to apply if medium-term inflation expectations no longer remained sufficiently well-anchored.

The ONS yesterday highlighted the fact that prices of food and non-alcoholic beverages had, overall, risen by less between November and December than at the same point of 2012.

Annual inflation in the food and non-alcoholic beverages category tumbled from 2.8% in November to 1.9% in December.

The ONS also cited reports of discounting of computer games, and it noted lower prices for computer games designed for older platforms.

The main upward pressure on the annual UK CPI inflation rate came from petrol and diesel prices, which rose modestly between November and December but fell at the same point in 2012. The ONS cited a small upward contribution from the first tranche of winter price increases for gas and electricity.

Samuel Tombs, UK economist at consultancy Capital Economics, said: "The fall in CPI inflation in December to the 2% target for the first time in four years shows that the economic recovery is not prompting price pressures to build. Indeed, CPI inflation looks likely to spend more time below 2% than above it during 2014."

Mr Tombs highlighted the fact that the core measure of annual UK CPI inflation, which excludes energy, food, alcohol and tobacco, dipped from 1.8% in November to 1.7% in December.

Noting subdued UK factory-gate prices, Mr Tombs said: "CPI inflation looks set to ease gradually to about 1.5% by the end of 2014. This will help real wages to finally recover and should enable the Monetary Policy Committee to leave interest rates on hold this year even if unemployment falls below the 7% threshold used for its forward guidance soon."

Annual UK inflation on the old all-items retail prices index measure edged up from 2.6% in November to 2.7% in December.

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