Pound hit by falling UK inflation

A key measure of inflation has fallen to its lowest level since September 2004, official statistics show, further weakening the value of sterling.

The Consumer Prices Index (CPI) dropped to an annual rate of 1.1% in September from 1.6% in August.

Meanwhile, the Retail Prices Index (RPI) inflation measure, which includes mortgage interest payments and housing costs, fell to -1.4% from -1.3%.

The pound fell 0.5% against the euro to a six-month low of 1.0628 euros.

It also fell to a five-month low against the dollar of $1.571, though pulled back against both currencies later.

'Frail'

"This is bad news for the pound," said Duncan Higgins, senior analyst at Caxton FX.

"The CPI figures will weigh heavily on the UK currency and will continue to discourage investment."

Sterling has been under pressure in recent days - including from a report by the Centre for Economics and Business Research - which predicted that UK interest rates would remain at their historic low of 0.5% until 2011 and would stay below 2% until 2014.

Figures last week showing that UK industrial output fell unexpectedly in August also cast doubt on the strength of the UK economy.

Meanwhile the National Institute of Economic and Social Research has revised its estimate for GDP, forecasting that the economy did not grow in the June-to-September quarter.

And the British Chambers of Commerce (BCC) has said that while business confidence was improving, the economy remained "frail".

'Spare capacity'

The Bank of England aims to maintain CPI inflation at 2% to keep both prices and the broader economy stable.

If CPI falls below 1%, the governor of the Bank of England will have to write a letter of explanation to Chancellor Alistair Darling.

The slide in inflation was greater than had been expected, but was largely attributed to the spike in energy prices seen a year ago, which meant prices in September this year were considerably lower.

Electricity, gas and other fuel bills fell by 7.3% on the year, the Office for National Statistics (ONS) said.

Overall prices in September were unchanged from those seen in August, the ONS added.

Rising energy prices meant that inflation was likely to rise again in coming months, said Jonathan Loynes of Capital Economics, adding that the return of VAT to 17.5% from its current temporary 15% level would also push CPI back towards 2% by turn of the year.

However, he forecast the "huge amount" of unused production capacity in the economy would eventually push inflation down sharply, "keeping alive the threat of a period of outright deflation late next year or beyond".

Deficit impact

Meanwhile chief economist at Schroders UK, Keith Wade predicted this would "probably will be the low point in inflation".

The inflation data showed that the Bank of England pumping of about £160bn into the the economy's money supply - so-called quantitative easing - had not yet taken effect, said James Hughes, chief economist at Black Swan Capital Wealth.

But he added that the huge budget deficit, welfare system commitments and "uncompetitive" exchange rate meant the supply of money had not yet fed through to prices.

Meanwhile, UBS economist Amit Kara said the inflation figures would be "a comfort" to the Bank's rate-setting committee.

"I think it's minded to expand the quantitative easing programme. This just provides the additional reason to do it."