Rate of inflation falls sharply

Posted on July 18th, 2012 | Categories - News

The Office for National Statistics (ONS) has announced that both rates of inflation have fallen dramatically moving closer to the Bank of England’s target rate.

Inflation measured by the Consumer Prices Index (CPI) fell to 2.4% in June, compared to 2.8% in May, against a target of 2%. The Retail Prices Index (RPI) also fell, from 3.1% to 2.8% over the same period.

Prices are now rising slower than at any point since late 2009, and it is the third month in a row that the rate of inflation has slowed, mirroring Bank of England expectations. The news will come as a huge relief to the Bank which has struggled to control inflation over the past few months, being reluctant to increase interest rates, the traditional method of curbing inflation, for fear of damaging the weak economy.

Many financial experts are predicting a relatively prolonged period of low inflation, with Vicky Redwood, Chief UK Economist at Capital Economics saying: “We think that CPI inflation could be below 1pc by the end of the year and is likely to stay very low throughout next year.”

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Lower prices

The fall in the rate of inflation was mainly driven by drops in the price of clothing and footwear as many retailers started their summer sales early. The drop in the price of fuel was also a major contributing factor with petrol falling by 4.3 pence per litre and diesel by 4.7 pence.

The inflation figures are good news for savers who until recently have been struggling to fine real returns on their savings accounts often having to tie up their capital in long term fixed rate bonds.

Not all good news

Whilst the slowdown in the rate of inflation will be welcomed by many it isn’t all good news.

Prices are still currently rising faster than incomes, causing a continued squeeze on household finances. Although some experts are predicting this will reverse later this year, meaning disposable incomes should start to rise, if only modestly.

A fall in the rate of inflation could also give the Bank of England more leeway to extend their program of Quantitative Easing (QE). The Bank has already injected £375 billion into the economy including an additional £50 billion last month, however it feel that with inflationary pressures easing there is more scope to stimulate the economy,

However, QE causes gilt yields to drop and has a knock on effect on Annuity rates. Any pension calculator  will show just how far Annuity rates have dropped over the past year, causing real financial hardship to many would-be retirees.

Low gilt yields also affect other retirement options such as Income Drawdown and Fixed Term Annuities, meaning there are few, if any, retirement income options not linked to gilt yields.