Surprise dip in inflation dampens calls for BoE to put interest rates up

The prospect of an early hike in interest rates by the Bank of England receded yesterday as prices rose by considerably less than expected last month.

The Office for National Statistics said annual consumer prices inflation declined to 2.2 per cent in October, down from 2.7 per cent in September – and well below the 2.5 per cent rate that economists had been anticipating.

Under its forward guidance policy the Bank of England has pledged to hold interest rates at their historic low of 0.5 per cent until the national unemployment rate falls to 7 per cent at least. But the central bank also built in a "knockout" whereby the guidance would cease to apply if inflation was forecast by the Bank's Monetary Policy Committee to be above 2.5 per cent at the end of its two-year forecast horizon. A growing number of people have been calling on the Bank to seize the initiative and raise rates sooner in order to dampen price increases.

However, yesterday's falling inflation rate makes such a rate hike less likely. "It dilutes the risk that the knockout clauses to forward guidance could be triggered," said Howard Archer of IHS Global Insight. Michael Saunders of Citigroup said the figures will ease the pressure on Threadneedle Street even if unemployment falls more rapidly than it has forecast. "The lower inflation path will allow the Monetary Policy Committee to maintain a pro-growth monetary stance even if (as seems likely) the jobless rate hits the 7 per cent threshold much earlier" he added.

The inflation undershoot sent down the value of the pound, which fell 0.4 per cent against the dollar to $1.592.

The ONS said the largest contribution to the inflation fall last month came from fuel prices and education. There was a smaller impact from university tuition fees because many students were already paying the higher rate, said the ONS. Core inflation, which strips out volatile food and energy prices, fell to 1.7 per cent from 2.2 per cent, the lowest level since 2009.

But analysts pointed out that rising domestic fuel costs would prevent inflation falling rapidly again over the coming months – EDF Energy announced yesterday that its prices will rise by 3.9 per cent from January. Relatively high inflation has contributed to an intense squeeze on real wages over the past five years, making yesterday's easing of prices rises widely welcomed. But pay growth has also been extremely weak in recent years, with the latest figures from the ONS showing average weekly wages grew at an annual rate of just 0.4 per cent in August.

The more timely VocaLink Take Home Pay Index, which monitors pay settlements in FTSE 350 companies, also fell last month. The rate of annual pay growth eased to 2.2 per cent, down from 2.4 per cent in September. Pay in manufacturing firms actually turned negative, down 0.7 per cent.

The ONS will today release its forecasts for pay growth in September alongside the latest unemployment figures. Meanwhile the Bank of England will unveil its own new growth, inflation and unemployment forecasts, with analysts expecting substantial revisions from its last August outlook.

Three months ago the Bank forecast that inflation would not fall to 2.2 per cent until the end of 2014.