Inflation drops despite pre-sales price hikes

Some retailers raised prices before Christmas by the biggest margin for 23 years in order to reduce them for the January sales. But behind the seasonal ups and downs, underlying inflation edged closer to its target. Diane Coyle, Economics Editor, asks what it means for interest rates.

Both the headline and target measures of retail price inflation fell fractionally last month, to 3.6 per cent and 2.7 per cent respectively. The figures suggested that rising interest rates have got underlying inflation back on course for its 2.5 per cent target, if not quite there yet.

Lower motoring costs - with a rise in petrol duty in the November 1996 Budget dropping out of the 12-month rate - and cheaper clothing and footwear were the main explanations for the decline.

However, there was strong upward pressure in December from the biggest monthly rise since 1974 in the price of household goods such as washing machines and furniture. The Office for National Statistics said the pattern of pre-Christmas price rises in preparation for January reductions had been getting more pronounced in recent years.

For example, the price of household goods, which usually climbs in November and December, was up 1.3 per cent last month. This compares with a 1 per cent rise the previous December and a 0.7 per cent rise in December 1992.

The typical January price fall has also grown bigger, growing from a drop of 2.3 per cent five years ago to a 3.6 per cent cut last January. Retailers typically raise prices again in February and March.

The year-on-year rate of increase in household goods prices has picked up, however, climbing from 0.9 per cent in September to 1.4 per cent last month.

Despite signs that strong demand is raising prices in some areas, economists welcomed yesterday's inflation figures. The small reduction led some who had expected a further quarter-point rise in interest rates next month to waver in their view, boosted by remarks by one member of the Monetary Policy Committee.

Charles Goodhart told a House of Lords committee that the Asian crisis "makes it likely the extent of rate increases will be less than they otherwise would have been" - although he was not referring specifically to UK interest rates.

Kevin Gardiner of Morgan Stanley said: "I'm not sure the good news will last, but the case for the Bank of England to wait and see next month has grown stronger."

This view was shared by the futures market, where gains yesterday implied a market expectation that the odds are now against another rate rise and that the level of borrowing costs will be falling by mid-year.

Although Budget duty increases for tobacco and alcohol, and some food price and fare rises can be expected to affect January's retail price index , the impact of the sales is expected to lead to another favourable figure for the target measure.

Separate US figures showed consumer prices climbed by just 0.1 per cent in December, making the inflation rate for 1997 as a whole just 1.7 per cent, the lowest since 1986.

The underlying rate increased by more during the month, rising 0.2 per cent, or 2.2 per cent year on year. But this was its lowest rate since 1965.