Consumer Inflation drops to 4.5%

Official figures released this morning show that UK inflation fell to 4.5% in October.

The Consumer Prices Index (CPI) measure fell to 4.5% after hitting 5.2% in September, the highest it had been since 1992.

The alternative method for measuring inflation is the Retail Prices Index, (RPI), which covers housing costs, has fallen from 5% to 4.2%, the biggest drop since 2003.

The Bank of England has said that next year inflation may fall below its 2% target to as low as 1%.

The UK economy shrank by 0.5% in the third quarter this year making it the first fall in 16 years.

This was one of the key reasons for the Bank of England's Bank Rate cut last month, taking the rate from 4.5% down to just 3% - its lowest level since 1955.

The rapidly slowing UK economy is easing the cost-of-living increases due to falling food and fuel prices – fuel was also pulled down by crude oil prices remaining under $60 a barrel.

The new figures released this morning - higher than economists had predicted - are expected to confirm this trend.

Figures from the Office for National Statistics, show that output prices (the price of goods leaving the factory) - fell by 1% last month. It also said the month-on-month drop in the CPI figure is the biggest fall in 16 years.

Input prices (the price of raw materials purchased by the manufacturers) fell by 5.6% in last month, the biggest drop in 22 years.

The Governor of the Bank of England, Mervyn King, has said it is now very likely that next year will see the UK's retail price index turning negative.

Economists are expecting another significant rate cut in December, with some predicting a full percentage point to just 2%, a level unheard of since the 1930s.

Economists have said a short period of deflation would not be a disaster, but a longer one could be.

According to economic theory, in lengthy periods of deflation, consumers hold back from buying goods in the hope that prices will fall in the not so distant future.

This can cause further economic problems as a fall in demand and output can lead to unemployment and pay cuts.

Ultimately, consumers then have less money to spend, and demand continues to fall, creating a vicious circle.

Written by Sam Gooch