UPDATE 2-UK inflation dip provides relief ahead of budget

Tue Mar 20, 2012 10:24am EDT

* Inflation down at 3.4 pct vs forecast of 3.3 pct

* Core inflation falls to 2.4 pct, lowest since Nov 2009

* CBI survey shows manfucturers ramping up production

* UK budget won't provide significant economic boost

By Sven Egenter and Olesya Dmitracova

LONDON, March 20 (Reuters) - British inflation edged down in February to the lowest level in over a year, keeping hopes alive that the severe squeeze on Britons' finances will ease at a time when the government has little room to boost the fragile economy.

Finance minister George Osborne presents his annual budget on Wednesday, and is aiming to provide some relief for low- and middle-earners while keeping up his austerity drive to erase Britain's huge budget deficit.

A slightly more upbeat economic outlook from the government's Office for Budget Responsibility (OBR) and a smaller need for extra borrowing will provide Osborne's statement with a more benign backdrop.

But the chancellor of the exchequer has batted back all calls to loosen austerity, leaving no scope for a significant economic stimulus. Barely half of analysts in a Reuters poll believe the government will balance its cyclically-adjusted budget deficit in five years.

Falling inflation is seen as crucial to help consumers to increase real spending and to keep the recovery on track, as the economy appears to have avoided a new recession.

However, the drop in the inflation rate to a 15-month low of 3.4 percent from 3.6 percent in January was slightly smaller than economists had forecast, highlighting the risk that price pressures won't fade as quickly as the central bank and the government hope.

INFLATION DECLINE

Sterling hit a session high against the euro and gilts fell after the data, as the slow decline in inflation reinforced expectations that the Bank of England will not favour further asset purchases once the current programme ends in May.

A raft of more upbeat news from the economy has dampened the need for futher stimulus and a survey showed on Tuesday that manufacturers are planning to increase production.

The Office for National Statistics said a drop in prices for electricity, gas, recreation and culture pushed overall inflation down, while a record rise in prices of alcoholic beverages contributed most to the increase in costs of living.

Economists had forecast inflation of 3.3 percent, extending a drop from September's three-year peak of 5.2 percent.

"The recent rise in oil prices didn't stop UK inflation from taking another step down in February, although progress has slowed a bit," said Capital Economics analyst Vicky Redwood.

Inflation may even pick up again briefly due to higher petrol prices and the risk of rising food costs. "However, these factors should just slow the speed at which inflation falls, rather than preventing it from dropping at all," she said.

In a sign that underlying pressures are fading, core inflation - which strips out components such as food and energy - fell to 2.4 percent, the lowest since November 2009.

EASING GLOOM

Britain's consumers cut back spending sharply as price rises outpaced meagre wage growth and the government's tax increases and spending cuts are also hurting household budgets.

The Bank of England forecasts that consumption should pick up later this year as it predicts inflation to fall below its 2 percent target by the end of 2012.

Britain's recovery from the 2007-2009 crisis has been weak, but with the euro zone debt crisis easing and the United States on track for more solid growth, the mood is improving.

The OBR is set to lift its growth prediction for this year a notch to 0.8 percent, and the government's budget is expected to show a smaller need for extra borrowing.

But a giveaway beyond raising the threshold from which taxes are paid and other minor tweaks to taxes are unlikely, and the government's measures such as a scheme to get credit to small firms will also do little to spur growth quickly.

The lack of consumption has driven a number of well-known high street brands out of business, and many retailers are now turning to discounts to lure cash-strapped Britons.

The chief executive of Britain's second largest department store group Debenhams Debenhams, Michael Sharp, told Reuters that selling price inflation was about 5 percent in the six months to March 3 but that he expected it to abate in the coming six months, particularly towards July and August.

"What typically happens is that prices take longer to come down than they do to go up," he said.

With the government's hands tied, the onus has been firmly on the Bank of England to support the economy.

But some of the BoE's Monetary Policy Committee members have expressed concerns about whether inflation would fall as fast as forecast, once the effect of one-off factors such as the impact of the rise in sales tax at the start of last year had faded.