This feature is part of our FREE daily Money Morning email. If you'd like to sign up, please click here: Sign up for Money Morning
Inflation plunged last month, from an annual rate of 2.4% in June to 1.9% in July.
It's the first time in 18 months that inflation has been below the Bank of England's 2% target.
Subscribe to MoneyWeek
Subscribe to MoneyWeek today and get your first six magazine issues absolutely FREE
Sign up to Money Morning
Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter
Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter
The news came as a surprise to most analysts, though there were cries of "we told you so" from estate agent pundits, keen to seize on any thin straw of hope for the housing market. After all, they argue, with inflation back below the target level, how can the Bank justify another interest rate hike?
But if you take a closer look at the data, things aren't quite as clear cut as they might seem
The dive in consumer price index inflation saw City pundits suddenly pushing back their expectations of an interest rate hike. But if we look at the inflation figures in a bit more detail, they are less reassuring than you might think.
The main drivers were falls in food, energy, petrol and furniture prices. Like it or not, all of these are temporary impacts. The price of furniture fell sharply, after rising sharply last month - that's just a standard summer sales tactic, to jack up the price of items just before they go on sale, so that they look even cheaper. So that's a one-off.
And with oil and food prices rising more generally - and with the impact of the floods on food supplies still set to be felt later this year - food and petrol price deflation can't be expected to continue, and it also seems unlikely that household energy bills will continue to fall.
The other point of concern is that clothing and footwear had the biggest upward effect on inflation, despite the summer sales. Cheaper clothes, due to a great extent to the impact of cheap Chinese imports, have been a major deflationary force in recent years.
Yet, there's more and more evidence that this may be coming to an end. China's inflation rate has soared to 5.6%, well above the government's 3% target. As the Chinese demand higher wages and their own living costs rise, it will become more expensive to produce goods there.
There's also the small issue of currency translation. As traders speculate that the Bank of England will no longer have to hike interest rates as rapidly - if at all - the pound has fallen below the $2 mark. A weaker currency drives up the price of imports, driving inflation higher - so a stronger yuan, combined with domestic inflation, could really drive up the costs of Chinese goods for UK consumers.
On top of all this, the Bank did point out in its recent inflation report that inflation could fall sharply in the latter half of this year. Even acknowledging that, it still indicated that at least another interest rate rise was needed to stay on top of things.
And we all know what happened the last time the Bank lost its nerve during a rate-hiking cycle. When the Monetary Policy Committee voted to cut rates by a quarter point in August 2005 (against the better judgement of governor Mervyn King), it introduced the notion of the "MPC put". This, like the "Greenspan put" in the US, was the idea that at the slightest tremour in the housing or stock markets, the central banks would race to the rescue with rate reductions.
That move undermined the Bank's inflation-fighting credibility and is now widely seen as a mistake - something which we argued all along.
The last thing the Bank will want to do now is to repeat that mistake at the first sign of a blip in the economy. We'd still be betting on the next move being a rate hike, rather than a cut.
If you have any comments about this piece, please email editor@moneyweek.com
Turning to the wider markets
Enjoying this article? Why not sign up to receive Money Morning FREE every weekday? Just click here: FREE daily Money Morning email
The FTSE 100 climbed steadily higher in earlier trade yesterday only to give up its gains in the final hours as news that US hedge fund Sentinel was seeking to halt withdrawals saw early falls on Wall Street. The blue-chip index closed 75 points lower, at 6,143, and the broader indices were also lower. For a full market report, see: London market close
Across the Channel, the Paris CAC-40 dived 90 points lower to end the day at 5,478. Societe General led the fallers on rumours that the bank's Lyxor asset management unit may announce losses at some of its funds. In Frankfurt, meanwhile, the DAX-30 shed 49 points to end the day at 7,425.
On Wall Street, stocks fell sharply on further bad news from the credit market. In afternoon trading, Thornburg Mortgage shares were down over 46% as the lender admitted to liquidity pressures. The Dow Jones tumbled 200 points to 13,028 as all but one of its components fell. The S&P 500 was down 26 points to 1,426. And the tech-heavy Nasdaq was 43 points lower, at 2,499.
In Asia, the Nikkei was down by as much as 369 points - at 16,475 - today. And the Hang Seng was as low as 21,386, a 620-point fall.
Crude oil had risen to $72.66 this morning and Brent spot was up to $70.53.
Spot gold continued to fall this morning as the dollar strengthened. It was last quoted at $666.25, down from $668.30 in New York late last night. And silver had fallen to $12.59.
In the foreign exchange markets, the pound remained below the $2 mark this morning, where it had fallen for the first time in six weeks yesterday, and was last trading at 1.9931. Sterling was at 1.4761 against the euro whilst the euro had fallen to 1.3494 against the dollar. And the dollar had fallen to 116.91 against the Japanese yen.
And in London this morning, brewer Scottish & Newcastle was a rare riser in early trading, climbing 1.3% on news of a possible bid by Danish peer Carlsberg. Both parties declined to comment on the possibility of a takeover.
And our two recommended articles for today...
How to avoid these six common investing mistakes
- By making common mistakes, investors often prove to be their own worst enemy, says the CFA Institute. To be sure you're not acting too rashly or making too many costly trades, see Tim Bennett's guide to avoiding key errors: How to avoid these six common investing mistakes
Why politics, not science, is driving the biofuels boom
- Not only are biofuels an inefficient way to burn food, but they could also lead to a future water crisis. So why is the US continuing to plough ahead with production? Garry White reports: Why politics, not science, is driving the biofuels boom
