Inflation slows even further to its lowest rate since 1939

Falling mortgage costs are behind the dip in figures. Bank expected to continue with quantitative easing

The recession has pushed inflation to its lowest level since before the Second World War. Prices fell by 1.2 per cent in the year to March, compared with a drop of 0.4 per cent in April, the retail prices index showed. The latest figure is the lowest since June 1939.

Much of the evaporation of inflation – and the apparent onset of deflation – was due to the huge reduction in mortgage repayments after the Bank of England slashed interest rates from more than 5 per cent to 0.5 per cent. However, the consumer prices index (CPI), which excludes such effects, also came down significantly yesterday. Helped lower by falling gas and electricity bills, the CPI registered a 2.3 per cent rise in prices in the year to March, against a 2.9 per cent increase in February.

So-called "core inflation", which strips out volatile items from the index, such as energy prices and food, also showed a downward trend, from 1.7 per cent to 1.5 per cent – indicating that underlying inflationary forces in the economy are easing rapidly.

The question now is whether the current run of falling prices will remain a relatively benign trend, boosting living standards for those in work, or whether it heralds a much less pleasant era of perpetually falling prices, depressed demand and stagnant output – as was seen in Japan over the past two decades or throughout much of the West in the 1930s.

Most economists agree that, despite the surprisingly mild readings yesterday, inflation will not turn to pernicious deflation, not least because the weak pound is pushing up import costs. Michael Saunders, of Citi European Economics, said: "So far this year, inflation has overshot consensus expectations more often than it has undershot and, with the rapid rise in import prices, the UK stands out as the only major country for which consensus inflation forecasts have risen this year.

"We suspect consensus inflation expectations remain too low, especially for next year, when the lift to prices from the weak pound will be compounded by the planned VAT hike."

Even though inflation is generally low, for the over-75s it remains high by recent standards – at 3.9 per cent, according to research by Alliance Trust. Food prices are still rising at a rate of 9.2 per cent per year. Economists agreed that weak inflation figures would prompt the Bank of England to press on with its programme of quantitative easing. "From a policy perspective, today's data is broadly in line with the Monetary Policy Committee's forecast of 2 per cent CPI inflation in the second quarter of 2009 and, as such, the MPC is set to maintain its £125bn asset purchase programme," said Amit Kara, an analyst at UBS.

"If anything, we expect the committee to expand that programme to £150bn or more in the coming months. That decision will depend crucially on some of the key lead indicators of near-term economic activity." The inflation figures did nothing to stop sterling enjoying a boost, gaining 1.6 cents to hit a 2009 high of $1.5501 against the dollar, though this seems to be down to other factors.

Philip Shaw, at Investec Securities, explained: "The story surrounding the Government selling stakes in Lloyds Banking Group and RBS has improved sentiment towards the banks, in turn bolstering sterling.

"The previous day's rally on Wall Street indicated that markets may still be hungry for risk assets, and this has also supported the UK currency."