Tempus analysis: Severely deflated

Factory gate inflation eased again last month as the cost of raw materials continued to fall sharply, fuelling expectations that the Bank of England will have to cut interest rates again to stave off the threat of deflation.

The price of goods leaving British factories fell by 0.7 per cent during November, taking the annual rate to 5.1 per cent — the lowest level since December last year.

Factory gate inflation peaked at 10 per cent in July this year.

The input price index, which measures prices paid for materials and fuels, fell 3.3 per cent in November, according to the Office for National Statistics. The fall followed a record 5.6 per cent drop in October, the biggest decline since 1986.

Economists said that the sharp falls indicated that consumer prices would also plunge in the coming months. Oil and commodity prices have tumbled in recent months and the Government's 2.5 per cent point cut in VAT will also drive down prices.

CPI inflation fell to 4.5 per cent in October, down from a 16-year high of 5.2 per cent in September, and the Bank of England has forecast that it will fall well below its 2 per cent target next year.

However, Howard Archer, chief UK and European economist at IHS Global Insight, the economic consultancy, said: "It seems highly likely that consumer price inflation will move back below the Bank of England's 2.0 per cent target level in the early months of 2009 and will turn negative during the second half of the year."

The sharp fall in inflation could is likely to pave the way for more rate cuts by the Bank as it strives to boost economic activity.

Paul Dales, UK economist at Capital Economics, said: “The further fall in UK producer prices in November provides more evidence that deflation is now becoming the greatest policy concern.

"Given that the manufacturing sector is facing its worst downturn since the early 1980s, core prices are likely to fall back in the coming months. Overall, these numbers support our view that the Monetary Policy Committee needs to cut interest rates even further to stave off the threat of deflation.”

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