Inflation drop paves way for new round of QE

http://www.guardian.co.uk/business/2012/jun/19/inflation-drop-new-round-qe

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Falling petrol prices on Britain's forecourts pushed inflation to its lowest level in two and a half years last month, opening the way for the Bank of England to take fresh action to stimulate the economy.

In a rare piece of good news for recession-hit households, the Office for National Statistics said the annual inflation rate slipped to 2.8% last month from 3% in April, as measured on the consumer price index.

Though inflation is still well above the Bank of England's target of 2%, the fall should help to reassure policymakers that they can embark on a new round of quantitative easing – buying government bonds with electronically-created money – without sparking a renewed surge in prices.

The ONS cited motor fuels as the biggest factor behind the decline in inflation, with petrol prices falling by 4.5p a litre in a single month to stand at £1.37.

Commodity prices have fallen sharply on world markets as investors fret about the likelihood of a global slowdown. During May the cost of a barrel of Brent crude slipped from $120 to $103. It has since fallen further, to just above $83.

On the retail price index measure, which includes housing costs, the ONS said annual inflation slipped to 3.1% in May from 3.5% in April.

The Bank of England governor, Sir Mervyn King, hinted in his Mansion House speech last week that the monetary policy committee (MPC) could unleash a renewed bout of QE, adding to the £325bn it has already spent, alongside the government's new measures for kickstarting credit.

The Bank also confirmed that is was release the first £5bn of its £80bn cut price loan scheme to banks on Wednesday. High street banks will be able to swap poor quality assets like credit card debt and commercial real estate loans for a six-month cash loan under the scheme.

Philip Shaw of Investec said: "We consider that there is a very good chance that the MPC will turn the QE taps back on next month. With inflation coming down sharply over the past couple of months, the economic data disappointing and global uncertainties rising, there doesn't appear to be much cause to hold back."

Minutes from the MPC's June meeting, to be published on Wednesday, will show how many of its nine members voted for more QE.

Central banks across the world's major economies are preparing to take emergency action to cushion the impact of the worsening eurozone crisis. Many on Wall Street are pinning their hopes on an announcement by the Federal Reserve on Wednesday of new measures to kickstart growth.

Despite the fall in inflation, prices in Britain are still rising faster than average incomes, which are increasing at just 1.8% a year, according to the latest official figures.

Cathy Jamieson, shadow Treasury minister, said: "The fall in the inflation rate is welcome as last year's VAT rise continues to drop out of the figures, but families and pensioners are still facing a harsh squeeze on their incomes from this government's policies."

John Zhu of HSBC pointed out that the fall in inflation was not just driven by lower petrol costs, but also weaker price growth across a range of consumer goods, suggesting retailers are struggling to raise prices for cash-strapped shoppers.

"A fall in petrol prices played a role, but there is a wider story," he said. "Retailers do not appear to be able to raise prices given weak demand. This should give the Bank of England confidence to extend QE and adds weight to our view of another £50bn of gilt purchases starting this summer."