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Inflation falls to lowest levels in four years

Written by Sam Jones on 14 January 2014.

We are pleased to see inflation fall to its lowest level in four years in December. The Office for National Statistics reports inflation met the Bank of England target of 2 per cent for the first time since November 2009.

The consumer prices index fell to 2 per cent in the year to December compared to 2.1 per cent in the year to November. It ends a long period of stubbornly high inflation based on rising food and petrol costs, which are now falling.

Inflation rocketed above 5 per cent in 2012, which policymakers blamed on international factors such as high oil prices and food imports.

The fall in inflation is largely down to food prices and recreational goods and services, offset by upward contributions from motor fuels.

Energy prices have also been an upward pressure with prices rising up to 10 per cent a year at the ‘Big Six’ energy companies during last autumn.

Mortgages are not included in the CPI inflation measure as it is based on a typical group of family purchases, not including property costs.

Fixed rate mortgage costs have plummeted in the last year though due to the Funding for Lending scheme providing banks with cheap loans to pass on to consumers.

Standard variable rates and tracker mortgages have remained static as the Bank of England maintains its 0.5 per cent base rate.

Interest rate impact

For mortgage borrowers we can see this will have an impact on interest rates and the timing of future rises to the Bank base rate.

Typically low interest rates give people more money allowing them to spend more, driving up demand and prices.

In normal times too low a Bank base rate has created high inflation. So when inflation rises the Bank of England rises rates has been an iron rule of UK economic policy.

These are not normal times and the Bank of England has kept its base rate of 0.5 per cent for nearly five years, a record low.

However, the same rules do apply and the more inflation stays around its 2 per cent target, the less pressure there is to raise interest rates.

Alongside other announcements from Bank of England governor Mark Carney this is another positive sign that rates will stay very low for longer.

Recovery

The economy has been rapidly improving with three quarters of consecutive growth in 2013 pushing up expectations of a rate rise.

Carney says he will not increase rates until unemployment falls below 7 per cent and even if it does he is likely to keep rates on hold for longer.

We can see how many mortgage borrowers have got used to ultra-low mortgage rates in the last five years and an increase could be a tough adjustment for many.

Any increases are likely to be slow and take place over a number of months and years to allow borrowers to move back to a normal price for credit and mortgages.

Inflation hitting target gives the Bank of England the space to manage interest rate rises over time and not rush into an early rise while the economy is still fragile.

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