According to the latest Office for National Statistics data, CPI inflation fell to 0.5 per cent in December from 1 per cent in the previous month.
The inflation rate fell from 1 per cent in November largely due to the collapse in the price of oil, which has fed through into lower electricity and fuel prices for UK consumers.
Last month’s rate is the joint lowest on record, matching May 2000’s figure.
Paul Hollingsworth, UK economist at think-tank Capital Economics, said the UK is set to come “within a whisker of deflation soon”.
He said: “Indeed, the further 20 per cent or so fall in oil prices since December’s average level looks set to push CPI inflation to a record low of around 0.2 per cent over next couple of months.
“And given uncertainties surrounding how quickly and to what extent lower oil prices will cause price rises for other goods to moderate, a brief period of deflation is not entirely out of the question.”
For investors, the UK policy rate outlook remains in the shadow of the looming general election and an increasingly divided electorate, according to Gautam Batra, investment strategist at Signia Wealth.
“The Bank of England also faces a tough task in setting policy considering the competing issues of eroding spare capacity alongside inflation being temporarily dampened by energy prices.
“We continue to believe that the bank will look past the transitory impact of weaker oil and will raise rates soon after polling day.”
Azad Zangana, senior european economist at Schroders, added that despite the sharp fall in wholesale energy prices, the savings have not yet been passed on to consumers and, as a consequence, inflation may lower further when they are passed on in the coming months.
“Another area falling global energy prices are affecting is transport fuel, where the average price of petrol has fallen from £1.31 per litre in July to £1.11p/l last week. Based on our analysis of the relationship with oil prices, we expect the price of petrol to fall by 8 pence per litre in the coming months.
“Overall, whilst the low headline inflation rate would ordinarily be seen as a sign of weakness in the economy, the external shock of low oil prices is likely to boost the disposable income of households, encourage greater spending, and raise economic growth for 2015.
“As a result, we do not expect the Bank of England to consider easing monetary policy at all in the near future.
“As global oil prices stabilise, we expect inflation to rise again next year, with the impact of recent falls falling out of the annual comparison. Therefore, the Bank could still consider raising interest rates this year, particularly if we see another year of strong growth – now more likely thanks to falling oil prices.”
Guy Ellison, head of UK equities at Investec Wealth and Investment, pointed out that the core inflation reading, excluding these more transient factors, actually increased marginally to 1.3 per cent year-on-year, which is this number which the Bank of England should focus on when considering rate policy.
“The broader reaction to today’s data is likely to be modest weakness for sterling, as the need for the BOE to raise rates sooner rather than later to ward off inflation diminishes,” he added.
Having hit 1.9 per cent in June, inflation fell steadily over the second half of 2014, with Hargreaves Lansdown’s senior economist Ben Brettell arguing the trend was no cause for concern.
“In contrast to the eurozone where weak prices are, at least in part, a symptom of an ailing economy, the fall in UK inflation should not be cause for concern. Given the fall is almost entirely caused by cheaper oil and food, it is good news for the UK economy.
“However, today’s data release further underlines the case for leaving interest rates on hold. Mark Carney has promised the Bank will ‘look through’ the effects of the falling oil price when setting monetary policy, but in reality it is almost impossible to see the MPC voting for higher rates while Mr Carney is penning regular letters to Mr Osborne.”
peter.walker@ft.com
