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Inflation peak seen as CPI drops to 5%

The rate of inflation is expected to drop significantly next year having stuck persistently above the Bank of England's 2% target.

Inflation peak seen as CPI drops to 5%

Inflation cooled slightly in October, the start of what economists say could be a long trend downwards.

The consumer prices index (CPI) rose 5% annually in October, slightly lower than expected, and down from the 5.2% rise measured the previous month when the majority of utility companies' energy price hikes took effect. The broader retail prices index (RPI) dropped to 5.4% annually in October, the data from the Office for National Statistics showed.

Falls in the cost of food, helped by a supermarket price war, as well as lower air fares and petrol prices dragged the CPI reading lower, although rising utility prices kept the index from falling lower.

Having stuck persistently above target – and surging recently after energy price hikes – the rate of inflation is expected to drop over the coming months.

In a letter to chancellor George Osborne, which Mervyn King was compelled to write after the above-target figure, the Bank of England governor said the Monetary Policy Committee expected that 'inflation will fall back sharply in the next six months or so, and continue falling thereafter to around target by the end of next year'.

14 November 2011

The Rt Hon George Osborne

Chancellor of the Exchequer

HM Treasury

1 Horse Guards Road



Dear Chancellor

The Office for National Statistics will publish data tomorrow showing that CPI inflation was 5.0% in October. In August I wrote an open letter to you because CPI inflation had remained more than one percentage point above the 2% target. As it is three months since I last wrote to you, and the rate of inflation is more than one percentage point above the target, I am writing a further open letter to you on behalf of the MPC.

In accordance with our remit, this letter explains why inflation has moved away from the target, the period within which we expect inflation to return to the 2% target, the policy action that the Committee is taking to deal with it, and how this approach meets the Government's monetary policy objectives. Following our usual procedure, the Bank of England will publish this open letter at 10.30am tomorrow. The Committee's latest judgements on the outlook for output and inflation will be published in the November Inflation Report on Wednesday 16 November.

Why has inflation moved away from the target?

CPI inflation fell back to 5.0% in October. But it remains well above the 2% target. As described in previous letters and Inflation Reports, the current high level of inflation reflects the increase in the standard rate of VAT earlier this year, and previous steep increases in import and energy prices, including recent domestic utility price rises. In the absence of those temporary factors, it is likely that inflation would have been below the 2% target.

Over what period does the MPC expect inflation to return to target?

As the impetus from external price pressures dissipates, and the increase in VAT drops out of the annual comparison early next year, the Committee's best collective judgement is that inflation will fall back sharply in the next six months or so, and continue falling thereafter to around target by the end of next year.

While we can be confident about the direction of change of inflation over the coming months, we remain uncertain about the precise pace and extent of the drop in inflation. It could fall back more slowly if companies attempt to restore profit margins by raising their prices, there is significant further pass through from previous increases in import prices, or the sustained period of above-target inflation becomes embedded in wage and price-setting behaviour. But it is also possible that inflation could fall back more sharply given the existing margin of spare capacity in the economy, the substantial risks around the global economic recovery and the implications of a further slowdown in the world economy for the United Kingdom.

What policy action arc we taking?

The key consideration for monetary policy is the outlook for inflation in the medium term, and the balance of risks around it, rather than the current rate of inflation. Since my previous letter, world growth has slowed and uncertainty about the prospects for the global economy, and in particular the euro area, has increased. Those developments, and accompanying falls in household and business confidence in the United Kingdom, are likely to have weakened the outlook for overall activity in the UK economy and so will probably lead to a greater and more persistent margin of spare capacity than previously thought. That made it more likely that inflation would undershoot the 2% target in the medium term, and is why, at its October meeting, the MPC voted unanimously to maintain Bank Rate at 0.5%, and to increase the size of its asset purchase programme by £75 billion. At its November meeting, the MPC judged that it was appropriate to maintain Bank Rate at 0.5% and the stock of purchased assets financed by the issuance of central bank reserves at £275 billion in order to balance the risks to the inflation outlook, relative to the target, in the medium term. Further details of the MPC's latest projections will be set out in the November Inflation Report to be published later this week. In evaluating the outlook for inflation, the Committee will continue to monitor closely wage growth, credit conditions, measures of inflation expectations, indicators of spare capacity, and overseas developments. The MPC stands ready to respond accordingly to changes in the balance of risks to the inflation outlook.

How does this approach meet the Government's monetary policy objectives?

The main risk facing the UK economy continues to come from the uncertain global economic

outlook, and the extent to which weaker global economic conditions threaten the recovery, and to postpone the necessary rebalancing of the UK economy. The MPC can use Bank Rate or asset purchases to help case the adjustment of the UK economy to these shocks, but there is a limit to what it can achieve when real adjustments are necessary. The best contribution that monetary policy can make to high and stable levels of growth and employment is to respond flexibly and transparently to bring inflation back to target in the medium term. The Committee remains determined to set policy to ensure that inflation is on track to meet the target in the medium term.

I am copying this letter to the Chairman of the Treasury Committee, through which we are accountable to Parliament, and will place this letter on the Bank of England's website for public dissemination.

Yours sincerely

Mervyn King [signed]

Economists agree that CPI could have fallen below the Bank England’s 2% target level by the end of 2012. 'The rate could well fall back to target in the next 12 months,' Chris Williamson of Markit commented today, as petrol price rises and January's VAT hike fall out of the year-on-year comparisons.

'The fact that supermarkets are currently engaging in a price war suggests that many retailers will increasingly feel the need to price competitively to get worried and pressurized consumers to spend,' added Howard Archer of IHS Global Insight.

However October’s reading will provide little comfort for struggling savers and investors who have limited options in the fight against inflation. According to financial research company Defaqto only six of the 1,999 savings accounts currently available give a real rate of return to basic rate taxpayers based on the latest CPI reading.

Older people are being hit particularly hard by rising prices, according to Age UK, which today published its 'Silver RPI' index showing that over 55s have seen an 18% rise in living costs since 2008, which is almost 5% more than the average.

The Bank of England is not expected to take action to tackle inflation by increasing the base interest rate from its long-held historic low of 0.5%, as it expects inflation to fall. Instead it is thought more likely to increase the amount it is spending to boost the ailing economy, with quantitative easing (QE), the bond-buying programme, amid growing threats to external demand and consumer confidence. Falling inflation gives the Bank more leeway to extend its asset purchases.

The Bank will publish its closely-watched quarterly inflation report tomorrow, where it will update its predictions for the future path of inflation and the economy.

22 comments so far. Why not have your say?

Anonymous 1 needed this 'off the record'

Nov 15, 2011 at 12:46

Inflation will never get down to the 2% target. Inflation is the only real means the government has to sort out its debt pile. While this is the case QE/low interest rates will prevail.

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alan thorburn

Nov 15, 2011 at 13:00

"Falls in the cost of food, well as lower air fares and petrol prices dragged the CPI reading lower..".

Where exactly is this happening Chris? Certainly not where I live in North ayrshire!

Food prices are STILL rising, Ryanair flights are more expensive than a year ago,

and petrol and diesel prices at the pumps have just risen once again!

You must be living in cloud cuckoo land!

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William Bishop

Nov 15, 2011 at 13:05

Agree with Anonymous 1's last sentence, but not necessarily his conclusion. I still do not see how any kind of wage/price spiral could get established with the current amount of economic slack, so it would require further commodity price appreciation and/or much weaker sterling for inflation to remain substantial. One might think that QE/low interest rates would cause the currency to weaken, but this ain't necessarily so, when others are doing much the same thing.

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Robert Court

Nov 15, 2011 at 13:06

The Bank of England has failed to meet the 2% target and cannot turn back time.

2% inflation for 5 years will increase an index from 100 to 110.40808

2% inflation for 2 years followed by two years at 5% followed by one year at 2% will increase an index from 100 to 116.998182

Getting inflation back down to 2% in year five still means your index is 6.59 over your target and I agree with the post above that once breached the target will now never be acheived.

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Rob Walker

Nov 15, 2011 at 13:32

Following on from Robert Court's point, isn't it about time we were given compounded inflation rates rather than year-on-year? If we were always reporting the absolute inflation rate for the previous (say) five years, or since the current government took over and then compared that to average income increases etc for the same period we could see the real effect on our lives. Why don't governments do this? I wonder why !

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Nov 15, 2011 at 13:33

The Bank of England's predictions on inflation are invariably below the reality.

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Keith Snell

Nov 15, 2011 at 13:38

There is far too much conjecture in trying to forcast inflation rates in 2 years time, neither is the government based index applicable to an individual, I believe the annual rate of inflation in Suffolk for a retired person with no mortgage to pay is approx 7%. What is certain is that if you are retired unless you have made some special provision to make up for inflation erosion of capital you will inevitably end up having to live in relative poverty compared with the best years of earned income, hence the difficuty in pension provision based on the Civil Service type final salary scheme with automatic annual increase. The current trade union stance in that respect only shows the complete ignorance of the costs involved, they do not even contribute anything worth counting either. If that is not cloud cuckoo land what is.

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Anthony O' Grady

Nov 15, 2011 at 13:56

Outright deflation remains an enormous risk in the medium term. Continuing deleveraging by banks and private households alike, supports a move towards deflation. This remains so despite the current level of inflation, and if the Eurozone breaks apart and the Southern European miscreants default, not to mention Italy, one will see deflation on a massive scale.

Read - Professor Steve Keen, David Kauders, Bruce Stout among others.

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Cynic too

Nov 15, 2011 at 14:08

Yes I think they are at it yet again fiddling the numbers - it's time this Chinese Accounting ceased forthwith! Must concur with Anonymous 1 et al.

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Nov 15, 2011 at 14:17


The true rate of inflation is 10%.

Ask yourself, what have your bills for the following done in the last year:





Public transport




Interest (Where not reference rate linked of course)


Rent on property

Student fees

The legacy of Tony Blair's labour government.

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Alan Tonks

Nov 15, 2011 at 14:26

Alan- I totally agree with you I have noticed no decrease in prices. As for the supermarket war that is a definite fantasy.

I will give a Tesco sample, cheese at 3.99 per 500g reduced to 3.19 (In their so –called price war) you might say that is good value. In fact before the WAR, it was 3.99 buy two for £5.00 so we actually have an increase of £1.38.

This is only one sample of many and yes to save you had to buy two but it was worth it.

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Nov 15, 2011 at 14:37

Alan Tonks- like the use of a nowadays rarely seen 4 letter word.Save. Albeit in respect of buying 2 portions of cheese.

Pity more people hadn't put this into practice in their personal budgets years ago.

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Nov 15, 2011 at 14:53

A new investment has just become available, being a 5 year product, either 17.5% gross or the increase in RPI during the 5 years, whichever the greater.

Subject to income tax. Can be used for Cash ISAs & Cash ISA Transfers - SIPPs. Falls within the FCSC £85,000 limit.

Given the ongoing events this is a good hedge against investment risk and interest rate risk.

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dr ray

Nov 15, 2011 at 15:20

BoE has been saying inflation will be below 2% in 2 years time for the last 3 years and even with changing the recognised measurement of inflation and fiddling the way price increases are recorded they still have inflation 250% above target and rising (bar a bit of statistical noise this month).

The trick is to make people believe that inflation will drop soon so that they don't demand higher wages while making sure inflation stays around 5-10% (depends how you measure it) as at present to bail out the debtors.

Also with inflation so low now as to be almost negligible there surely can't be any reason to hold back on another round of money printing (Ha ha ha)

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ian k

Nov 15, 2011 at 15:28

When the BOE pension scheme moves out of inflation linkers then is the time to belive its dead.

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Nov 15, 2011 at 15:29

Price inflation will stay above 4%. Wage inflation will stay below 4%. Eventually the deficit will be inflated away as a result of the declining value of sterling.

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Myron Martin

Nov 15, 2011 at 16:15

Take it as a given that whatever rate of inflation any government reports, you can pretty well DOUBLE it as far as ACTUAL inflation for the average persons real living costs. NEVER trust a politicians or economists predictions on future inflation, they are just uneducated guesses because they all failed mathematics.

When our currency is borrowed into existence as debt, requiring the payment of interest, but the fractional reserve banking system never creates that interest, (only the principal of a loan is ever created) then what we are doing is simply "COMPOUNDING DEBT" through roll overs and additional loans to cover the interest, building a DEBT PYRAMID that has no limit. Even 2% inflation (really interest in disguise) will destroy a fiat currencies purchasing power in just 50 years because they have no intrinsic value like gold and silver.

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Eddie B

Nov 15, 2011 at 17:14

Inflation is generally good for the economy.was £75bn of QE enough..... I think we will not see 2% for a number of years.

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Jem Cooper

Nov 15, 2011 at 18:14

So when exactly will it be the right time to raise interest rates from their historic low? If not with inflation at two and a half times target and with unsustainable borrowing everywhere, then when? Surely not when inflation is back under control next year, ha ha!

In thirty years time when the pound is worth less than today's penny, economics students will fall about laughing in disbelief when told about the reckless incompetence of the BoE and the government that connived at their blind stupidity. They will learn that nobody challenged the thinking at the time, but that is only because nobody hears us.

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Ryan McC

Nov 15, 2011 at 20:08

Could it be that lower inflation is being purported to validate further QE? I agree with those above who acknowledge and observe that fuel and food price decreases is absolute rubbish!!! I have noticed, as i'm sure have many others, that when the price of oil went up, so did the price at the pumps. When the price of oil fell back, the price at the pumps did not - major discrepancy here and it makes my blood boil when i hear of 'record profits' being posted by the major oil companies. When are we going to stand up to these avaricious people? On the current economic path we are now embarking, i don't think it should be too long!

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Ryan McC

Nov 15, 2011 at 20:11

Further to my comment, the use of the word 'people' could easily be replaced with a more suitable term. I will leave that up to the imagination - i couldn't possibly put the word i would like to have used on here.

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Nov 16, 2011 at 00:08

Ryan McC - short term price fluctuations do seem rather unfair but you are pointing your ire at the wrong people. As ever the politicians are not solely to blame, just vastly to blame!

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