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Surprise fall in UK inflation

CPI, the government’s target measure of inflation, fell to 4.2% in June, down from 4.5% in May. This took economists by surprise, as there was a general expectation that inflation would rise this month.

The inflation bubble hasn't burst yet, but there has been a temporary deflation at least.

The biggest reason for the fall was the drop in prices in the recreation and culture category, which largely reflected lower prices for computer games and audio-visual equipment and related products. On top of this there was downward pressure from miscellaneous goods and services, telecoms equipment and mobile phone charges and second-hand cars. However, upward pressure on prices was exerted by food and energy prices.

RPI inflation was also down from 5.2% to 5.0% in June, reflecting the same main factors as affected the CPI. RPIX inflation, which is the all items RPI excluding mortgage interest payments, was 5.0% in June, down from 5.3% in May. However, the UK CPI at 4.5% is still well above the EU average of 3.2%.

This fall in inflation appears to validate the Monetary Policy Committee’s decision to keep interest rates at 0.5%, even at a time when the European Central Bank has raised its interest rate.

What was particularly interesting in the latest figures is that the core inflation, which strips out volatile elements such as energy and food, actually fell from 3.3% to 2.8%. This probably reflects the tightening in household budgets which has exerted some downward pressure on prices, especially with many retailers currently closing stores or going into administration.

However, there is a very real possibility that prices will start to climb again over the next couple of months. British Gas has just announced increases in gas and electricity prices of over 15% and there are still further increases to come in retail food prices, reflecting earlier increases in food commodity prices.

But as these food price increases and the rise in VAT start to fall out of the picture next year, we should see the CPI starting to fall back quite rapidly to within the MPC’s parameters.

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Posted in Inflation

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