June 19, 2012 / 8:37 AM / in 8 years

Surprise inflation fall lifts chance of BoE stimulus

LONDON (Reuters) - Inflation eased unexpectedly in May to its lowest in two and a half years due to slower price rises for food and fuel, strengthening the chance of more Bank of England stimulus as the economy increasingly feels the heat of the euro debt crisis.

A woman pays a market trader for goods in Soho's Berwick Street Market in central London May 17, 2011. REUTERS/Paul Hackett

Britain entered its second recession since the 2007-2009 financial crisis around the turn of the year, and signs that the euro zone crisis was deepening prompted policymakers last week to announce a plan to flood the country’s financial system with billions of pounds to get a recovery moving.

In addition, BoE Governor Mervyn King hinted that more quantitative easing might be on the cards, and the chances that the programme will be restarted next month have been boosted by Tuesday’s official inflation figures.

The Office for National Statistics said consumer price inflation slowed to 2.8 percent on the year from 3.0 percent in April, confounding economists’ forecasts for an unchanged reading.

“King’s comments last week indicated that more QE will soon be forthcoming and these figures might help to sway any of the more wavering members into voting for more stimulus,” said Vicky Redwood, economist at Capital Economics.

Sterling weakened against the euro and British government bonds briefly rose after the data was released.

British inflation has been above the BoE’s 2 percent target since December 2009 and its slow fall earlier this year had made some central bankers reluctant to inject more cash into the economy despite signs that the recovery had stalled.

Between April and May, average consumer prices dropped by 0.1 percent - the first fall between these two months since records began in 1996.

“(This) is good news and is providing some welcome relief for family budgets,” a Treasury spokesman said.

The BoE has blamed high inflation for sluggish consumer spending - which drives about 60 percent of Britain’s gross domestic product - and a forecast fall in inflation is one of the reasons why it reckons growth will pick up later this year.

The central bank predicted in May that inflation was likely to remain above target until the second half of next year before falling to around 1.6 percent in two years’ time.

The biggest contribution to May’s fall in the annual inflation rate came from a slower annual increase in the cost of motor fuel - its smallest rise since October 2009 - as oil prices dropped in the face of global economic weakness.

Another drag came from slower price inflation for food - particularly grapes, bananas and peaches - while rises in airfares due to the timing of Easter created the main upward pressure.

The one fly in the ointment was a year-on-year increase in core inflation, which strips out volatile food and energy costs and is sometimes viewed as a better underlying guide to price pressures in the economy. This edged up to 2.2 percent from 2.1 percent in April, although some economists played down the importance of the move.

“Core inflation nudged up,” Redwood of Capital Economics said. “But this mainly reflects a brief period of sharp discounting this time last year and we had thought it would pick up more sharply than this.”

Additional reporting by Fiona Shaikh; Editing by Catherine Evans

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