MercoPress. South Atlantic News Agency

UK November retail inflation drops to 4.1%; deflation fears

United Kingdom consumer price index fell to 4.1% in November from 4.5% in October. As a result, the Governor of the Bank of England Mervyn King wrote his third letter of the year to the Chancellor of the Exchequer, explaining why inflation was so far above its target level (2%) and what the Monetary Policy Committee was planning to do to bring it back down again.

Given the short term outlook for inflation, it is quite possible that I will next need to write to you to explain why inflation has deviated by more than one percentage point below the target during 2009" said Mr. King. In fact, the BoE Monetary Policy Committee needs to do very little to bring inflation down. Over the next twelve months, it is going to fall sharply anyway and the likelihood is that it falls so far that the next letter the Governor has to write will be an explanation as to why inflation is too far below its target. Large increases in energy and food prices were the cause of the bulk of the rise in inflation in the UK in 2008. Lower energy prices will cause inflation to fall in 2009. Already, cuts in petrol prices have helped to bring inflation down from a peak of 5.2% in September. Next year, lower gas and electricity prices will cause inflation to tumble. If food price inflation, which was still running at over 10% in November, moderates to more normal levels and the recession leads to a more general easing in inflation pressures in the economy, which is what most UK economic models would predict, then inflation will drop below 1% even before taking into account the effects of the reduction in VAT from 17½% to 15%. This will take about another one percentage point off inflation, raising the prospect of a zero, or even a negative, rate of inflation for a number of months in the second half of next year. Many economists fear that deflation will deepen and prolong the recession because consumers will delay purchases in the expectation that prices will soon be lower. It is this prospect that now most worries the BoE Monetary Policy Committee. They are likely to react to the risk of deflation by cutting the bank rate again early next year to historically low levels, probably to 1%, and perhaps even lower. However last week, Chancellor Alistair Darling told the Treasury Committee that he did not see deflation as being a significant risk. Despite the continuing fall in inflation, many commentators expect the Bank of England's Monetary Policy Committee to cut interest rates still further from the current level of 2% - a 57-year low.