Recession helps push inflation to five-year low

Lower gas and mortgage bills drive down rate to 1.1%

Inflation fell to a five-year low in September of 1.1 per cent, pushed dramatically down by lower gas and electricity bills as well as continuing low mortgage interest payments and the generally depressing effects of the recession. The news came as the deputy governor of the Bank of England, Charles Bean, said that the Bank's policy of quantitative easing – injecting money directly into the economy – was "having the expected effects on the economy".

The Office for National Statistics reported yesterday that inflation on the consumer price index fell to an annual rate of 1.1 per cent last month, down from 1.6 per cent in August. The retail price index, which also includes the effect that the lowering of Bank rate has had on mortgage bills, fell further into negative territory. According to the RPI, prices fell by 1.4 per cent in the year to September, slightly up on the 1.3 per cent decline seen in August. A 75-year record of 1.6 per cent deflation was recorded in July.

"Core" inflation, which strips out volatile items such as food, alcohol and fuel, was also down, to 1.7 per cent from 1.8 per cent the previous moth.

The ONS said that almost all of the moderation in CPI inflation was due to gas and electricity prices, which were sharply higher this time last year because of the spike in the oil price and the depreciation of sterling. Gas bills were 5.6 per cent lower year on year in September while electricity prices were down 7.2 per cent. Other sharp declines in inflation were seen in food, restaurant and hotel bills, and for DVDs.

Economists had expected a smaller drop in inflation, and many now believe that inflation has reached a trough. Prices will, in any event, rise in January when the cut in VAT from 17.5 per cent to 15 per cent is reversed. A recent rise in commodity prices will also drive inflation higher, even as the economy struggles to recover from the worst downturn in three-quarters of a century. As it stands, inflation is just above the lower end of the Bank's target range of 1 per cent either side of a 2 per cent rise in the CPI.

Thus, for now, the Governor will be spared the chore of writing an open letter of explanation to the Chancellor.

Inflation is also running slightly higher than the Bank predicted in August in its last Inflation Report. Then, Mr King said: "It is more likely than not that later this year I will need to write a letter to the Chancellor to explain why inflation has fallen more than 1 percentage point below the target." Inflation will probably rise above 2 per cent early next year.

Although inflation is extremely low by British historical standards, it is still high internationally. Annual CPI inflation has been negative in the euro area, US and Japan for some time.

Opinion was divided on whether the inflation figures mean it is more or less likely that the Bank will extend its policy of quantitative easing at the November meeting of the Monetary Policy Committee. Howard Archer of Global Insight said: "The data will fuel suspicion that the Bank could yet extend its quantitative easing programme by a further £25bn to £200bn given its still serious concerns about the strength and sustainability of the recovery."

However Simon Ward, the chief economist at Henderson, said: "Today's numbers do not warrant a further expansion of the Bank's quantitative easing programme. There is evidence that the Bank's gilt-buying is creating excess liquidity in the economy and a further monetary injection could lead to an accelerating decline in the currency."

Little of the Bank's intention was given away by Mr Bean yesterday. He rejected the idea that the commercial banks were "sitting on reserves" and argued that QE was working through, making it easier for companies to raise funds though equity and bond issues.

Benefit rates: Pensioners to get £2.40

This month's inflation figures will be used by the Government as the basis for the uprating of many pensions and benefits next April.

The current negative RPI rate would logically imply a cut in the pension – politically unthinkable – or at least a freeze. But after the backlash against the 75p increase in the basic state pension in April 2000, when inflation was similarly ultra-low, ministers agreed to an underpinning arrangement – a minimum rise of 2.5 per cent. As a result, the basic state pension will rise from £95.25 to £97.65 for a single pensioner, and from £152.30 to £156.15 for a couple, a real-terms increase close to the rise in average earnings. (Though oddly, the calculation of weightings for the RPI excludes pensioner households.)

Other non-income related benefits such as incapacity benefit and disability living allowance are also linked to RPI, but with no positive minimum; they will be unchanged.

The big public-sector pension schemes – the NHS, the Civil Service, teachers and the armed forces – as well as some in the private sector are also linked to RPI, but without any minimum rise being applied, so they will be frozen – still a real terms increase.

Income-related benefits such as jobseeker's allowance, housing benefit and income support are linked to a special variety of the RPI called the Rossi Index, after a social security minister in the last Conservative government, Sir Hugh Rossi, who introduced it. The Rossi index is RPI less rent, mortgage interest and council tax. In September the annual rise was 1.8 per cent.