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CPI Falls

The Consumer Price Index (CPI), a key measure of inflation, has fallen for the first time since the first quarter of 2006, dropping by 0.3% to 2.7%. While its fall was not unexpected (the recent rises in the Base Rate have been made primarily to reduce the CPI), it is the amount of change that has come as something of a surprise – this is the single biggest month to month drop since Q4 of 2001.

Such a fall is good news for those with mortgages and other loans especially, as with the CPI running closer to it’s target of two percent, the Bank is less likely to increase interest rates again within the next few months as it will most probably adopt a ‘wait and see’ approach and closely monitor whether this is a one off drop, or if it will be a continuing trend.

Interest rates have seen three increases since last August, last month being the most recent of those. This month saw rates held unchanged, most likely because the MPC (Monetary Policy Committee) was aware that the CPI had fallen in January (they are privy to data before public release).

The reduction in the Consumer Price Index is largely attributed to the drop in the cost of oil during the last quarter of 2006, which manifested itself as cheaper petrol at the pump, as well as reducing haulage costs, savings which filtered into the inflation figures. Oil prices have begun to rise again, however gas prices are falling, so it is unlikely that overall energy costs will push the CPI higher in the near term.

Despite the dramatic fall in inflation, it should be noted that it is still running above target, significantly so in fact. With energy prices currently unpredictable in anything other than the very near term, it would be quite easy for inflation to shift upwards quickly, this is something that the Bank wouldn’t like to see, as it is already very close to the 3% upper limit (anything over that and the Governor Mervyn King would be require to account for the reasons to the Chancellor Gordon Brown). It is therefore possible that the Bank will want to take the opportunity to bring inflation down towards the 2% target while the energy situation is somewhat more predictable, which would give them more headroom in the future.

With the inflationary drop, the immediate pressure on the Bank and it’s Monetary Policy Committee has been lessened, giving them some time to assess just where the economy stands without having to make immediate changes to the base rate. This period won’t last long however, and it is likely that a further increase in rates will be required during the second quarter of this year, if this does occur it will likely be the peak for this rate cycle.