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9 February 2012updated 22 Oct 2020 3:55pm

Chart of the day: the spectre of deflation

Why the Bank of England is troubled by falling prices.

By George Eaton

Explaining its decision to pump another £50bn of quantitative easing into the economy, the Bank of England cited the danger that inflation could “undershoot the 2 per cent target in the medium term.” The spectre of deflation once again haunts Threadneedle Street.

Today’s chart of the day shows how inflation has plummeted in recent months on the back of lower fuel and clothing prices. From a peak of 5.2 per cent in September 2011, CPI inflation has fallen to 4.2 per cent, while RPI inflation has fallen from 5.6 per cent to 4.8 per cent.

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This month’s figures (for January 2012) will show another big fall as last year’s VAT rise, which automatically added 2.5 per cent to prices, is removed from the equation. This, combined with the easing in commodity prices, low wage growth and the retail price war, means that inflation is likely to fall faster than many expect.

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All of which explains why the Bank is firing up the printing presses again and why interest rates will remain at their record low of 0.5 per cent for the foreseeable future. Deflation, as Japan learned during its “lost decade” in the 1990s, slows economic activity as consumers postpone spending decisions in anticipation of even lower prices. With most forecasters expecting quantitative easing to reach £500bn by the end of this year, today’s monetary injection is unlikely to be the last.