Deflation worries grow - but RBS bounces back

As inflation tumbles to 3.1%, the Government faces another headache - on top of our money pit banks...

Last Updated: 31 Aug 2010

Consumer price inflation fell by another 1% last month, down from 4.1% to 3.1%, as the Government’s VAT cut and heavy pre-Christmas discounting continued to push prices down. It’s the biggest monthly drop since 1992, although the (moderately) good news was that it wasn’t quite as steep a fall as many economists were expecting – the consensus forecast was about 2.7%. So inflation is still running more than 1% above the Bank’s 2% target – but Governor Mervyn King is much more concerned about the prospect of under-shooting this in the coming months...

The inflation picture has changed pretty rapidly in the UK – a few months ago, when oil prices were at their peak, soaring inflation was the big problem for the Bank of England, restricting its ability to cut interest rates. But since fuel and commodity prices started tumbling in the face of waning demand, inflation has come down with it. At the same time, retailers have been slashing prices in a bid to get us into their stores, and the Government, desperate for us to keep spending money, cut VAT to 15%. So inevitably, prices have fallen; indeed, on the alternative Retail Prices Index measure (which includes housing costs), inflation fell from 3% to 0.9%. And CPI looks to be heading in the same direction.

Although falling prices might sound like a good thing, deflation can be pretty disastrous for the economy – people put off purchases in the expectation that prices are going to keep falling, accentuating the downward spiral. And Bank governor Mervyn King is definitely worried about this prospect: in his last letter to the Chancellor, he warned that inflation could fall below 1% this year, forcing him to write letters of explanation about why the rate is too low. So the fact that it's falling less quickly than expected probably counts as good news.

On the other hand, given the way Government is pouring endless sums of cash into the banking sector, ramping up the national debt to extraordinary levels, it won’t be long before it’s forced to print more money to pay for it all – which means we’ll be worrying about rampant inflation again before too long. Good job the Government’s put an end to the era of boom and bust, right?

At least RBS’s share price has rebounded this morning. The Government’s Really Bad Shareholding plummeted a massive 67% yesterday, following news of its prospective £28bn annual loss. With the Government forced to pump in another £5bn or so of taxpayers’ money (taking its stake to 70%), and with the worst of its losses potentially still to come, nationalisation looks increasingly possible – so shareholders have been dumping their stock as rapidly as possible. However, its shares rose by 24% this morning, along with most of the other banks – only a measly tuppence-and-a-bit in real terms, admittedly, but at least it’s going in the right direction...

In today's bulletin:

President Barack Obama's poisoned chalice
Deflation worries grow - but RBS bounces back
Burberry downsizes as progress checked
Asos boosted by young trendies
Editor's blog: The problem with British cars

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