Faltering global growth has pushed UK inflation to its lowest since 2009, raising expectations that the Bank of England will restart quantitative easing to stimulate the economy.
Falling commodity prices helped to lower the UK’s annual consumer prices index inflation rate from 3 per cent in April to 2.8 per cent in May as food price inflation slowed and fuel prices dropped.
The data took economists by surprise and strengthened their conviction the BoE would loosen monetary policy further in the coming months.
“This all makes the [BoE] Monetary Policy Committee’s job a little easier,” said David Tinsley, an economist at BNP Paribas, who noted inflation was now on course to undershoot the short-term forecasts the MPC published last month. “There is therefore little stopping the MPC unleashing another burst of QE at its next meeting.”
Last week, Sir Mervyn King, the bank’s governor, hinted the central bank would restart its gilt purchase programme, also known as quantitative easing, as he unveiled other measures to try to unblock the flow of credit to the real economy. The intensifying eurozone crisis has pushed up bank funding costs and hurt confidence at a time when the UK is already in a double-dip recession.
Hiren Jogia, head of UK inflation trading at Credit Suisse, said the market was expecting more QE to be announced in August. “We believe there’s definitely a strong chance of that being brought forward to July,” he added.
Inflation measured by the alternative retail prices index, which includes a measure of mortgage costs, fell from 3.5 per cent in April to 3.1 per cent in May.
Oil and food prices were the big drivers: the petrol price dropped 4.5p a litre to £1.37 a litre between April and May; food prices rose 0.3 per cent compared with a rise of 1.3 per cent between the same two months a year ago.
Britain’s economy has been hampered for two years by persistently high inflation that has outstripped wage growth and constrained consumer spending.
Tuesday’s data brought CPI inflation down from its peak of 5.2 per cent in September to the lowest since November 2009. Nonetheless, it did not settle the fierce debate among economists over the reasons for the country’s unusually high inflation rate or over the likelihood that it would continue to hover above target.
Simon Hayes, an economist at Barclays Capital, said the fall in inflation in May was largely attributable to lower oil prices. “This is just general global weakness feeding through ... It’s a presentational aide to the MPC if they do want to go ahead and do more QE but it still doesn’t remove the concerns they may have that the underlying inflationary forces in the economy are stronger than they previously appreciated.”
The BoE revised its inflation forecasts upwards as recently as May, predicting inflation would remain stubbornly above the 2 per cent target for another year, in part because it thought the productive capacity of the economy had been damaged.
So-called core inflation, which strips out volatile food and energy prices, rose slightly in May to 2.2 per cent, though this was influenced by technical factors involving air fares and the timing of Easter.
However, Michael Saunders, an economist at Citi, said he thought Sir Mervyn’s backing last week for a big new credit-easing programme together with signals of more QE to come meant the MPC’s May inflation report had already been discarded. “I think the governor has basically grabbed the steering wheel and told the MPC that their forecasts are wrong.”
Mr Saunders said the data “support our view that the long period of UK inflation overshoots is now ending and that inflation is likely to undershoot MPC and consensus forecasts in coming years”.
Citi predicts that by the end of the year inflation will have dropped to 2 per cent and the MPC will have announced another £125bn worth of gilt purchases.