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Inflation drops further in August

18/09/2007

Inflation fell to its lowest level in more than a year in August, according to official data which has sparked further speculation that interest rates in the UK may have peaked.

The consumer price index (CPI), the government's preferred measure of inflation, dropped back to 1.8 per cent in August – down from 1.9 per cent in July.

News of the unexpected fall leaves the official rate of inflation below the Bank of England's two per cent target, with the annual rate of consumer price inflation at its lowest level since February 2005, when it stood at 1.7 per cent.

The Office for National Statistics (ONS), which released the figures, said a reduction in the cost of financial services and mortgage exit administration fees had acted as the most significant downward pressure on prices.

Falling gas and electricity bills also contributed to the fall in the rate of inflation as a result of the continued phasing-in of tariff reductions by energy providers.

The price of clothing and footwear also fell last month, with the cost of women's clothing rising by less than at the same time last year, while the price of appliances and personal care products also dropped.

However analysts stressed that inflation as measured by the retail prices index (RPI), which unlike the CPI includes mortgage interest payments, remains high. The RPI rose to 4.1 per cent in August, up from 3.8 per cent in July, with the increase blamed by a rise in average mortgage interest payments as a result of a previous interest rate hike.

Capital Economics spokesman Jonathan Loynes added that unless oil prices started to fall "very soon" energy costs were likely to pick up sharply in the coming months, thus fuelling overall inflation.

Global Insight chief economist Howard Archer agreed, stating: "We believe that the Bank of England will remain very wary for now about any early trimming of interest rates, given that current elevated oil prices and possible future rises in food prices as a result of the bad weather could exert upward pressure on inflation over the next few months."

However he added that the UK's central bank would be closely monitoring the impact of current market turmoil on the country's economy and would be more likely to trim borrowing costs if it appeared that the global credit crunch and Northern Rock crisis had affected the outlook for growth.

Earlier this month the Bank of England opted to leave the UK's benchmark interest rate on hold at 5.75 per cent. The move had been widely expected given the credit fears that are continuing to unsettle the world's financial markets in the wake of rising mortgage default levels in the US housing market.