Market View: CPI could drop to 1 per cent this year

Last month inflation fell to its lowest level since September 2009, the sixth consecutive month it has been below the Bank of England’s 2 per cent target, which has been seen as positive for the prospects of real incomes.

Data published by the Office for National Statistics revealed today (17 June) that inflation dropped to an annual 1.5 per cent in May.

The headline rate of inflation was driven down by falling air fares between April and May, compared to a rise at the same point in 2013, Rob Harbron, senior economist at the Centre for Economics and Business Research, said.

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He added that the organisation expects earnings to increase at a faster rate as the year progresses, boosted by sustained economic expansion and a strengthening of the UK labour market.

Falling inflation demonstrates that strong growth in economic activity is not prompting underlying price pressures to build and the pick-up to 1.8 per cent in April was entirely due to the later timing of Easter this year, according to Samuel Tombs, UK economist for Capital Economics.

Mr Tombs added: “Looking ahead, it continues to look likely that CPI inflation will ease further, perhaps to as low as 1 per cent by the end of the year.

“For a start, sterling’s further appreciation points to a continued easing of core goods inflation over the rest of this year.”

The lower rate will mean people will have on average more disposable income, with research carried out by Scottish Friendly in June showing the level of UK disposable income has risen by 3 per cent in the last quarter.

Neil Lovatt, director of Isas and savings at Scottish Friendly, said: “People should be aware that this brief spell of financial freedom is likely to change when the Bank of England raise interest rates.”

After the BoE hinted at a potential interest rate rises before Christmas, further falls in inflation are likely to fuel that speculation, and consumer disposable income will start to fall as people adjust to rising mortgage repayments, according to Mr Lovatt.

Although the MPC has kept the base rate at 0.5 per cent, “many banks are already increasing the rates they offer borrowers,” pointed out Jeremy Duncombe, director at the Legal & General Mortgage Club.

He said: “This means that the historically low mortgage deals now available won’t be around for much longer. The average rate for borrowers on a two-year fixed mortgage is currently 2.68 per cent, compared to 3.67 per cent for the same product 18 months ago.”

Mr Duncombe called a rise in interest rates is inevitable, as the economic outlook improves. He said: “Banks are already pricing in this increase so it is vital that they act now to get a good deal.”