Prospect of deflation nears

Inflation in June undershot the Bank of England's target for the first time in two years last month. The consumer prices index (CPI) fell to 1.8 per cent in June from May's 2.2 per cent, below the government's two per cent target. However the RPI, which includes mortgage interest payments, which have plummeted recently, registered a 1.6 per cent year on year fall, the sharpest decline since records began in 1948.

An easing in the rate of increase in food prices was behind much of the fall - they are now rising by 5.4 per cent annually, down from nearly 15 per cent last year. Overall, retailers are finding it all but impossible to raise their prices in the face of the recession, with job losses restricting consumers' spending power.

While the deflation seen in the RPI is causing some to worry that the UK is entering a deflationary spiral, others point to the improvement in the housing market as evidence to the contrary. It certainly gives the Bank of England food for thought as it considers the future of quantitative easing, which it is likely to re-think as a result of any self-sustaining improvement in the economy. With economists forecasting a decline in inflation towards zero per cent this year, that time does not look to be nearing.

WHAT THEY ARE SAYINGAdam Posen, new BoE member, in the London Evening Standard: "The risks right now are more about deflation than inflation. Once you fall into a deflationary situation, it is very hard to get out. Interest rate cuts and quantitative easing combined with the fiscal stimulus is the right way to face this." ·