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UK inflation at record low, Carney sharpens pencil

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UK consumer price inflation fell to 0.5 percent in December, down from 1.0 percent the previous month. This is the joint-lowest reading on record, matching that of May 2000. By Ben Brettell, Senior Economist, Hargreaves Lansdown

Having hit 1.9 percent in June, inflation has been steadily falling over the second half of 2014, and the recent sharp fall in the oil price has accelerated this trend. Food and motor fuels have historically accounted for a large proportion of the inflation rate, but in the year to December food prices fell by 1.9 percent and motor fuels by an enormous 10.5 percent. Mark Carney will now be required to write a letter of explanation to the chancellor, but in truth the fall in the oil price makes this an easy letter to write.

InflationFalling inflation no cause for concern

In contrast to the euro zone where weak prices are, at least in part, a symptom of an ailing economy, the fall in UK inflation should not be cause for concern. Given the fall is almost entirely caused by cheaper oil and food, it is good news for the UK economy. The effect should be broadly similar to a tax cut, easing the pressure on household budgets and boosting consumer spending.

However, today’s data release further underlines the case for leaving interest rates on hold. Mark Carney has promised the Bank will ‘look through’ the effects of the falling oil price when setting monetary policy, but in reality it is almost impossible to see the MPC voting for higher rates while Mr Carney is penning regular letters to Mr Osborne. The effect of lower oil prices, plus the ongoing supermarket price war, could keep inflation below 1 percent for a number of months.

Economic growth also looks to be weakening, with leading think-tank the NIESR forecasting Q4 GDP growth will come in at just 0.6 percent. The falling oil price should provide a boost, but given the absence of inflationary pressure, it is difficult to see why the Bank of England would even consider higher interest rates at present. I fully expect them to remain on hold throughout this year and into 2016. 

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