Inflation ‘to fall sharply next year’

Vicky Redwood, chief UK economist at Capital Economics, said the cost of living was likely to fall below the government’s target because of the weakness of the British economy. Capital Economics is predicting nine months of negative growth – a recession.

Figures from the Office for National Statistics show that the government’s preferred measure of inflation, the consumer prices index, dropped from 5.2 to 5.0 per cent in October – still well above the 2 per cent target. The retail prices index, which includes housing costs, fell from 5.6 to 5.4 per cent.

Supermarket discounts

The drop in inflation was helped by the biggest fall in food prices at this time of year since 1996, a result of heavy discounting by supermarkets. Energy supplier npower’s decision to increase its charges for gas and electricity is continuing to put pressure on consumers, who are struggling to cope with average wage growth far below the rate of inflation.

Ms Redwood told Channel 4 News: “Inflation might see a pick-up before the year’s out, but next year we should see it fall sharply below the 2 per cent target. The drop was a bit larger than we and other people had been expecting, mainly driven by food price inflation coming down.”

Inflation might see a pick-up before the year’s out. Vicky Redwood, Capital Economics

Capital Economics expects inflation to drop to 1.5 per cent by the end of 2012. It also forecasts a double-dip recession, with three quarters of negative growth: -0.3 per cent in the final quarter of this year, -0.1 per cent in first three months of next year and -0.1 per cent in the following three months. Positive growth is not expected until the final quarter of 2012.

Ms Redwood said her company’s forecasts were lower than some economists were predicting. “I think we’re on the gloomy side, but more people are beginning to expect some kind of recession.We expected growth to be weak for domestic reasons, like the fiscal squeeze. We’ve reviewed down our forecasts due to the eurozone crisis and the knock-on effect on UK exports.”

Eurozone

George Papandreou and Silvio Berlusconi have been forced to resign as the prime ministers of Greece and Italy because of the state of their countries’ public finances. Greece,which cannot afford to repay its debts, is being bailed out by the EU and IMF, while Italy is seeking to avoid a similar fate under a new technocratic government led by former EU commissioner Mario Monti.

Mr Berlusconi’s departure last week was triggered by a rise in Italian government bond yields to above 7 per cent, a level almost reached today on the markets. Governments borrow money by issuing bonds (IOUs), and yields rise when investors worry that they might not get their money back. The result is that governments find it more expensive to borrow. Ireland, Portugal and Greece turned to the EU and IMF for help when they were facing interest rates of 7 per cent.

Italian debts

Italy has debts of 1.9tr euros. If it defaults, there is not enough money in the EU bailout fund to support it. This is what is spooking the markets, which are worried about the possible break-up of the euro.

The EU statistics agency, Eurostat, released figures on Tuesday showing that growth across the 17-country eurozone rose by just 0.2 per cent between July and September, with the German and French economies growing by 0.5 and 0.4 per cent respectively.