Shock fall in UK inflation gives BoE room to act again

LONDON Tue Jul 17, 2012 7:21am EDT

LONDON (Reuters) - British inflation fell faster than forecast to its lowest level in more than 2-1/2 years in June, reflecting weak demand in a shrinking economy.

At just 2.4 percent, annual consumer price inflation was slightly more than half the 4.2 percent rate at the end of last year and a shadow of the 5.2 percent peak last September.

The figure gives the Bank of England more leeway to inject extra stimulus into the economy, which is already in recession and facing a prolonged period of austerity as the government strives to cut a bloated budget deficit.

The Office for National Statistics said on Tuesday that the 2.4 percent rate -- down from 2.8 percent in May - was the lowest since November 2009. That confounded economists' forecasts for an unchanged reading.

Vicky Redwood, an economist at Capital Economics, pointed to an unexpected decline in core inflation, which excludes volatile food and fuel costs.

"The main surprise was the drop in core inflation from 2.2 percent to 2.1 percent. A period of sharp discounting this time last year had suggested that base effects would push the core rate up. But instead, it looks as though this year saw even more aggressive discounting," she said.

Bad weather -- Britain suffered one of its wettest Junes in years -- also quashed spending.

The pound briefly fell and British government bonds pared losses after the data was released.

"This gives the Bank of England plenty of room to respond aggressively to the downturn in activity," said ING economist James Knightley.

The central bank extended its asset-buying stimulus program by 50 billion pounds to 375 billion pounds ($586 billion) on July 5 and Knightley said he expected the program to reach 450 billion pounds by the end of the year.

The biggest downward contribution to the annual inflation rate came from a fall in the prices of clothes and footwear, followed by slower inflation in transport and food costs, the ONS said.

The International Monetary Fund said on Monday that Britain's growth prospects for the next two years had worsened more than those of any other big advanced economy over the past three months.

In a quarterly update to its World Economic Outlook, the IMF cut its British growth forecasts for 2012 and 2013 by 0.6 percentage points each, to just 0.2 percent and 1.4 percent respectively -- well below what Britain's official forecaster, the Office for Budget Responsibility, predicted in March.

The Bank of England and the government will be hoping that the lower inflation will push consumers to spend.

But some economists questioned the effect lower inflation was likely to have on the economy.

"How quickly consumers latch on to that is less sure as typically nominal wage growth is limited and prices are still rising," said Ross Walker at RBS.

In a sign that pipeline inflation pressures were also easing, British factory gate inflation hit its lowest since October 2009 in June on the back of lower oil prices.

Shop price inflation also slowed last month, as weak demand pushed retailers to offer deep discounts, according to a survey. ($1 = 0.6403 British pounds)

(Editing by Jeremy Gaunt)

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