Low rise in cost of living prompts tentative hopes of a cut in interest rates

Inflation is under control but house prices may tumble and cause a 1990-style crash, according to an economist
12 April 2012

Hopes of a cut in interest rates were raised today by new figures showing the UK's cost of living rose by its lowest rate in more than a year last month.

Figures released by the Office for National Statistics (ONS) showed that the official measure of inflation fell to 1.8 per cent in August from 1.9 per cent in July.

The Consumer Prices Index (CPI), has not been this low since last March, with the unexpected drop attributed to cheaper clothing and recent energy price cuts.

Lenders also helped push the cost of living down by slashing their mortgage exit fees following the introduction of new best practice guidelines.

Inflation has now been below the Government's 2 per cent target for two months in a row.

This has eased the pressure for further interest rate rises and given some hope of a possible cut, although experts fear inflation could creep up again after oil hit another all time high of 81 US dollars (£40.52) a barrel.

The increase have left motorists braced for higher petrol prices on the forecourts, while the ONS also believes the foot and mouth outbreaking and the summer flooding could cause a hike in meat prices.

Rising wheat costs are also pushing up the price of bread, which may see the CPI end its five-month run of decreases.

Economists, however, said the Bank of England would be relieved at the CPI drop which came as a surprise to many, with markets forecasting it to remain unchanged.

Howard Archer, chief economist at Global Insight, said the CPI figures strengthened the case for rates to remain on hold, although it may be too soon to expect a decrease in the cost of borrowing.

He said: "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."

While an immediate cut may not be on the cards, today's CPI news gives the Bank room to consider a decrease if needed to ease the turmoil in financial markets.

Investec economist David Page said: "We do not think the headline rate stands in the way of a rate cut, if the Monetary Policy Committee decides that it is warranted to get money markets functioning again."

The recent crisis in global credit markets has caused turbulence on stock markets and has already brought mortgage bank Northern Rock to its knees.

The new ONS data also revealed a widening gap between the official inflation rate and inflation including mortgage repayments, with the difference between the two now at a seven-year high.

The Retail Prices Index (RPI), often seen as a more representative measure as it includes mortgage costs, rose to 4.1% from 3.8% in July.

The gap between the two has not been so large since September 2000 and RPI has not risen this fast in more than a year.

The ONS said RPI hit 4.1% largely as a result of mortgage lenders passing on the July quarter-point increase in interest rates to borrowers. RPI without mortgage costs was unchanged at 2.7%.

Higher food costs also contributed to the RPI rise and it is thought this could start to push up headline inflation over the coming months.

The new data was released as Simon Rubinsohn, chief economist at the Royal Institution of Chartered Surveyors, warned of a one in 10 chance that the UK could be heading for a 1990s-style house price crash.

The expert said he thought there was a 10 per cent chance the value of property could fall steeply.

He said there is also a 20 per cent chance that house prices in London could fall by 10 per cent during the coming 12 months.

But he thought it was most likely that house price growth would remain flat during the coming 12 to 15 months, down from his earlier forecast that prices would rise by 3 per cent.

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