Inflation rate falls: Bank chief warns over lending support

Published on Tuesday 16 December 2008 11:00

BANK of England Governor Mervyn King gave another big hint today that extra help could be needed to get banks lending again.

The comments came in his letter to Chancellor Alistair Darling to explain why inflation was still more than double the Bank's 2% target at 4.1% in November.

Mr King wrote: "Additional measures, building on the Government's package to support the banking system announced in October, will probably be required to underpin lending to households and companies."

The Governor's words will spark further speculation over a potential package of so-called "quantitative easing" – pumping more money into the economy in a bid to spur on lending.

The Chancellor, who yesterday agreed to lower the cost of the Government's credit guarantee scheme for banks, said in reply that he would keep this and other measures to support lending "under review".

As the UK economy lurches into recession, Mr King said it was "quite possible" that his next letter to the Chancellor would be to explain why inflation had fallen more than 1% below the Bank's 2% target.

Consumer Prices Index (CPI) inflation – the official measure of inflation – dropped to 4.1% last month from 4.5% in October, official figures showed today.

The fall has brought inflation down to its lowest level since June and comes after a sharp drop the previous month, when inflation fell at its fastest rate for 16 years.

Tumbling fuel inflation – which saw its largest decline since records began in 1997 – helped bring CPI down for the second month in a row, according to the Office for National Statistics (ONS).

Global recession fears have brought the cost of crude plunging down from its peak of nearly 150 US dollars a barrel earlier this year to just over 45 dollars today.

The easing in oil prices saw the average price of petrol in the UK fall by 9.3p a litre between October and November, to 95.2p a litre, said the ONS.

Meanwhile, hefty drops in house prices and the Bank of England's dramatic 1.5% cut in interest rates last month helped bring Retail Prices Index (RPI) inflation down to its lowest level since April 2006.

RPI, which includes mortgage interest payments, dropped to 3% in November from 4.2% the previous month – the fastest decline for more than 17 years.

November's fall in CPI was not as big as economists had been expecting, having pencilled in a decline to 3.9%.

But the impending UK recession and the Government's reduction in VAT to 15% from 17.5% earlier this month is set to bring inflation down even further.

The ONS estimates that if the VAT cut was passed on in full, it would wipe 1.3% off CPI.

The VAT changes are also set to delay next month's inflation figures by up to two weeks as it impacts pricing calculations, according to the ONS.

Experts are now predicting months of negative inflation next year, although many do not believe that the UK will suffer a period of sustained deflation.

The potentially delayed December inflation figures are expected to show an even bigger fall in CPI as the VAT effects and Bank of England rate cuts begin to impact inflation.

Hetal Mehta, senior economic adviser to the influential Ernst & Young Item Club, said: "Next month's inflation data should show a much steeper drop, particularly on the RPI measure, as the VAT reduction and larger interest rate cuts feed through.

"Item believes that, by next year, RPI inflation will be in negative territory and the CPI measure will almost certainly undershoot the 1% threshold."

JP Morgan Chase economist Malcolm Barr said the November CPI data would have likely failed to take account of the 20% cut-price limited period sales discounts offered by retailers such as Marks & Spencer and Debenhams, leading to the higher-than-expected reading.

But he added that the surprise upside in CPI had not affected his predictions for a further 0.5% cut in interest rates next month, to 1.5%.

Tomorrow's minutes of the Bank of England's latest interest rates meeting will shed more light on the Monetary Policy Committee's thinking on inflation and rates.

There are reportedly concerns that the weakness of the pound may prevent the Bank from cutting rates as fast as they would like.

The performance of the pound has been hit hard as inflation expectations have plunged, with sterling falling to new record lows against the pound this week.

But Mr Barr said: "We remain comfortable with the call for a further 50 basis point move in January at this stage, with the move reflecting a compromise between data that suggest an ongoing need to act aggressively versus concern on the rapidity of weakness in the currency."