Inflation set to continue coming down

THIS week’s inflation figures – out tomorrow morning – are widely expected to show a continuation of the recent downward trend with a consensus forecast of a 1.8 per cent rise in prices year-on-year.

Inflation – as measured by the consumer prices index (CPI) – is expected by both analysts and the Bank of England to trough in the third quarter of 2009. The CPI has proved very sticky, despite the central bank’s best efforts to bring down prices. But the Retail Prices Index (RPI), on which many wage settlements are based, is in negative territory

Citigroup’s Michael Saunders said: “CPI inflation will probably fall further in coming months, but the low is likely to be about one per cent year-on-year.”
Peter Dixon, UK economist at Commerzbank, said: “The decline has probably been even less marked than you might have expected. Inflation has been quite sticky, partly because of the fall in sterling.”

But with the inflation rate expected to fall below the Bank of England’s two per cent target for the first time since September 2007, there are signs that the loose monetary policy is starting to work.

The Monetary Policy Committee (MPC) last week held off from extending its programme of quantitative easing (QE), surprising the markets and causing some analysts to propose that QE is coming to an end.

Michael Saunders expects that the MPC will stop QE in August and said: “The August Inflation Report will probably forecast that stable 0.5 per cent rates and £125bn QE will leave inflation slightly above target two years ahead, implying that no further QE is needed.”

But while the most negative viewpoint held by economists is that the unwinding of QE and gradual monetary policy tightening could cause inflation to shoot up sharply, there is little inflationary pressure in the UK economy and such rampant rising prices is generally held to be an unlikely consequence.