The spectre of 1930s-style deflation in the British economy loomed yesterday after figures showed that prices of many goods slumped last month as recession tightened its grip.

Consumer price inflation posted its biggest drop since records began in 1992, falling to 4.5 per cent last month from a 16-year peak of 5.2 per cent in September.

The drop could lead to further aggressive interest rate cuts. Rates are already at a 54-year low of 3 per cent.

Some analysts forecast that the Bank of England could slash rates to 1 per cent next year, but were sceptical that this would be enough to head off the threat of deflation.

Jonathan Loynes, of Capital Economics, said: “These inflation figures are the first step along a road that is likely to end in the first bout of deflation in the UK economy in almost half a century.” He cautioned that the current economic downturn could exacerbate the problem, leading to a “Japanese-style deflationary spiral”.

Britain suffered a few sporadic months of deflation in the late 1950s and 1960, but the last time that consumers faced years of sustained price falls was in the Great Depression of the 1930s. The drop in inflation last month was driven by falling petrol, food and clothing prices, trends that are tipped to continue, with one analyst saying that inflation would “drop like a stone” over the coming months. Petrol prices fell by 6.1 per cent in October, after a 1.5 per cent drop in September, figures from the Office for National Statistics (ONS) showed, and data from the AA suggested that prices were continuing to slide. The average cost of a litre of petrol fell from 106.4p in mid-October to 94.9p in mid-November, cutting the cost of refilling the tank of a family car by nearly £6, the AA said.

Annual food price inflation also eased, from 12.7 per cent in September to 11.2 per cent last month.

Air fares fell by 6.4 per cent and the cost of ferry tickets dropped by more than 12 per cent. Second-hand cars also declined by 2.1 per cent, taking the annual fall in forecourt prices to 10.5 per cent. Photographic equipment is now nearly 24 per cent cheaper than in October last year.

Core inflation, which excludes volatile energy and food costs, also fell during the month, from 2.2 per cent to 1.9 per cent, the ONS said. This is the first decline since February, indicating that shops are being forced to trim prices to entice customers during the downturn.

The Bank of England has said that inflation will fall well below its 2 per cent target to as low as 1 per cent by early 2010. Mervyn King, the Bank’s Governor, has also cautioned that the alternative measure of inflation, calculated on the retail price index (RPI), could fall below 0 per cent. RPI, which fell from 5 per cent to 4.2 per cent in October, is tipped to fall farther and faster than consumer price index inflation as it includes mortgage costs, which have been tumbling after sharp interest rate cuts.

Howard Archer, of Global Insight, the economic consultancy, said: “It does seem particularly likely that headline retail price inflation will go into negative territory in 2009 due to sharply lower interest rates.”

Expectations of further cuts in interest rates were reinforced yesterday by Tim Besley, the most hardline member of the Bank’s rate-setting Monetary Policy Committee. Professor Besley confirmed that he had abandoned his previously hawkish stance and backed the Bank’s assessment that plunging world commodity prices would drive inflation below target next year, creating scope for still lower rates.

He indicated that he was likely to support further rate cuts as he highlighted how the credit crunch was hampering a boost to the economy from lower interest rates. This suggested that he was likely to favour deeper cuts in rates to offset this problem.

Professor Besley also indicated that the fall of the pound, the overall value of which is at its lowest since 1996, was unlikely to prove a concern. Gordon Brown has acknowledged the threat of deflation as he and the Chancellor prepare for next week’s Pre-Budget Report, when tax cuts are expected.

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