Inflation is down – but will it stay there?

In September, for only the third time in 18 months, Britain's inflation was lower than expected. But what is the future: inflation, deflation or stagflation?

For only the third time in 18 months, inflation was lower than expected. In September the annual rate of consumer price inflation (CPI) fell from 1.6% in August to 1.1%, a five-year low. The retail price index, which includes mortgage rates, edged down further to 1.4%. A slide in gas and electricity prices (which were hiked last September) and a decline in food prices were chiefly responsible for the drop in CPI. The news dealt sterling another blow.

What the commentators said

"This is only a temporary move lower," said ING's James Knightley. Petrol prices will make a "major" contribution to inflation over the next few months, as oil fell sharply at the end of last year. And the VAT cut from 17.5% to 15% will be reversed in January. Sterling's "plunge" will provide further upward impetus. The upshot is that inflation is set to be "well above" the 2% target early next year.

Yet don't expect it to become entrenched, said Nils Pratley in The Guardian. So far, "governments and central banks have stopped the rot, but not much more than that". This doesn't look like a self-sustaining recovery. Unemployment is still going up, taxes will rise and bank lending remains tight. "That mix seems highly unlikely to produce permanent inflation anytime soon."

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Indeed, the key danger is still deflation, said Capital Economics. The downward pressure of the "huge amount of spare capacity" that is opening up in the economy, thanks to the recession, means inflation is set to fall below zero again late next year. So a "deflationary spiral" is still a "key risk" for policymakers, and the Bank of England should consider even more quantitative easing.

But the idea that there is a "huge reservoir" of excess capacity, and that supply thus dwarfs demand, is wildly overblown, said Liam Halligan in The Sunday Telegraph. The financial crisis, "by starving firms of credit, has destroyed vast swathes of supply". So all the money printed will generate "serious" inflation once the banks stop sitting on it and demand recovers. The Bank of England's latest minutes even concede that it "may have misjudged the amount of slack in the economy".

Meanwhile, rising inflation could combine with the lacklustre recovery to create stagflation scant growth with relatively high inflation. As Pratley put it, it's "best to keep an open mind" on how all this will play out. The one certainty, however, is that none of the ways out of this mess will be easy.