UK inflation rate drops to 3.6 percent

[February 14, 2012]  LONDON (AP) -- Britain's inflation rate fell to 3.6 percent in the year to January from 4.2 percent the previous month, official figures showed Tuesday, to the likely relief of cash-strapped households which have seen muted pay increases more than eaten up by rising prices.

The figure published by the Office for National Statistics on Tuesday was in line with expectations and put inflation below 4 percent for the first time since December 2010. The fall came as last year's sales tax increase dropped out of the annual comparison. Lower fuel prices also contributed to the decline.

The U.K. consumer price inflation (CPI) rate peaked at 5.2 percent in September.

Though inflation has been running above the Bank's 2 percent target since December 2009, rate-setters have kept borrowing costs at record low levels and recently approved another monetary stimulus in response to falling output -- recent figures showed the U.K. economy contracted 0.2 percent in the last three months of 2011.

The central bank has held its policy line despite elevated inflation rates, arguing that price pressures would diminish this year. Markets will be interested to see if Wednesday's quarterly economic projections from the bank show inflation falling below target later this year.

Many economists think that's a distinct possibility and that the Bank will back even more stimulus in the months ahead.

Last week's announcement that the Bank will be splashing out another 50 billion bounds ($79 billion) in asset purchases raised the total monetary stimulus since the program started in March 2009 to 325 billion pounds.

The hope is that by increasing the amount of money in the financial system, the purchases, known as quantitative easing or QE, will loosen credit for businesses and raise asset prices. Quantitative easing can be inflationary, but analysts say the bank has room to act.

Howard Archer, chief European economist at IHS Global Insight, said inflation could fall to 2 percent by the end of the year.

"We believe the improving inflation backdrop will give scope to the Bank of England to provide further stimulus to the economy," said Archer, who is predicting another 50 billion pounds stimulus in May.

Meanwhile, James Knightley, analyst at ING Bank, said inflation could drop to 1 percent by year-end.

"Inflation expectations tend to follow actual inflation and, given that the CPI appears to be heading sharply lower, we expect inflation expectations to do likewise," he said.

"This should further limit the risk of above-target inflation becoming entrenched, with workers unlikely, and unable given rising unemployment, to push for larger pay rises."

Wage increases have remained moderate despite high inflation, rising just 2 percent per year in the latest survey.

[Associated Press]

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