Further QE called for as inflation stalls

Published on Tuesday 18 August 2009 21:11

BUSINESS leaders yesterday argued the case for further printing of money to help drag the UK economy out of recession, despite clear signs of inflation stickiness.

Official figures showed consumer prices were unchanged last month, pegging the annual rate of inflation at 1.8 per cent. Analysts had predicted a further easing below the Bank of England's (BoE) 2 per cent target to 1.5 per cent.

The annual core inflation rate, which strips out energy, food, alcohol and tobacco costs, rose from 1.6 to 1.8 per cent – the highest level since November 2008. Meanwhile, the broader measure of RPI (Retail Prices Index) inflation, on which most wage deals are based, rose from -1.6 per cent in June to -1.4 per cent last month, against market forecasts for a sharper decline.

Analysts expressed some surprise at the numbers but most agreed that the halt in the downward trend in inflation will prove to be only temporary.

The British Chambers of Commerce urged the central bank to avoid tightening its monetary policy, noting that recessionary pressures on businesses were still "severe".

David Kern, chief economist at the BCC, said: "Although these figures are higher than expected, they should not be used as a reason for withdrawing the MPC's (monetary policy committee] policy stimulus. The key policy priority must be to alleviate the recession and help the economy return to growth."

Consumer inflation has been on a downward trend since hitting 5.2 per cent in September last year, but it has not fallen as quickly as forecast in recent months due to a weak pound.

RPI has fallen much lower than the official measure of inflation because it includes housing costs such as mortgage payments and council tax and has been pulled down by record low interest rates.

The BoE, which expects consumer price inflation to drop to 1 per cent this year, has slashed borrowing costs to an historic low of 0.5 per cent and unleashed a 175 billion quantitative easing programme to get banks lending and the economy growing again. However, inflation has repeatedly surprised on the upside despite the worst recession since the end of the Second World War.

Much of the reason for the surprisingly strong reading in July came from computer games and DVD prices, which rose this year but fell last year.

Alcohol also had an upward effect although there was some downward price pressures from meat, vegetables and take-away food.

Continued signs of inflation stickiness may dampen expectations of any further easing of monetary policy.

Royal Bank of Scotland economist Ross Walker said: "It does call into question further quantitative easing and even the latest policy decision.

"There is a troubling stickiness here. We are over a year into a pretty deep recession and we have core CPI rising and CPI stuck fractionally below its target."

Vicky Redwood of Capital Economics warned deflation remained a risk.

"The near-term path of inflation is still likely to be pretty bumpy, not least because of the impact of the planned reversal of the VAT cut at the start of next year," she said.

"Nonetheless, we still think that inflation will fall below 1 per cent later this year and could drop to very low, or even negative, levels in 2010 and 2011."

Sam Hill, fixed income manager at asset management firm Threadneedle, said the economy was entering "a phase where deflation will be the greatest threat to investors' money".

He added: "Restricted access to affordable capital and the paring back of wages could still end up trumping even the formidable stimulus package from the Bank (of England]."

&#149 The rate of inflation facing people over 75 remained unchanged at 2.8 per cent in July, meaning older people face price hikes 56 per cent higher than the official rate of inflation, according to figures from Dundee-based Alliance Trust.