The Governor's letter to the Chancellor | The Chancellor's response

Plunging prices for petrol and oil recorded their steepest fall for more than a decade last month sending Britain’s inflation rate tumbling again.

Headline inflation in November on the consumer prices index dropped sharply again, to 4.1 per cent. This was down from 4.5 per cent in October and from record levels of 5.2 per cent in September to its lowest since June.

The fall extended inflation’s slide back towards the Bank of England’s 2 per cent target. However the smaller than expected drop was not nearly enough to prevent Mervyn King, the Bank’s Governor, being forced to write his third explanatory letter since June to the Chancellor.

The Governor is required to write to the Chancellor every third month in periods when inflation exceeds its target by more than a full percentage point, what the Bank is doing to return it to the target.

Mr King had little difficulty explaining this in his latest letter to Alistair Darling. With the recession sending inflation plunging, he told the Chancellor that it was now expected to return target in the first half of next year and then “move materially below it later in the year”.

The Governor added to worries that inflationary pressures could fall so sharply that the Bank will soon confront the threat of deflation.

“It is possible that I will not need to write a further open letter to you in three months time,” he wrote to Mr Darling. “Indeed, given the short-term outlook for inflation, it is quite possible that I will next need to write to you to explain why inflation has deviated by more than one percentage point below the target during 2009.”

While the Government’s temporary cut in value-added tax (VAT) is set to wipe 1.3 per cent off inflation if passed on in full by retailers, the Governor also made clear that the Bank would set aside both this, and the subsequent upward effect on inflation when VAT returns to its previous level, when it takes its interest rate decisions.

The waning danger from inflation and the looming threat of a deep and protracted recession has already seen the Bank order drastic cuts in interest rates by 2.5 percentage points in the past six weeks, taking them to an historic low of just 2 per cent. Rates are expected to fall even further next year.

Fuel was the driving force behind today’s latest sharp reversal of inflationary pressure. On the CPI figures, overall fuel prices dropped by 8.3 per cent last month alone, leaving them 3.6 per cent down on their levels a year earlier. This was the first time that the annual rate of fuel inflation has been negative since last August.

The steep fall in fuel inflation came after the average price of petrol fell by 9.3p a litre between October and November, to 95.2p a litre, the Office for National Statistics reported.

Other factors conspired to limit yesterday’s drop in inflation, however. The main upward pressure came from food prices, with the cost of fruit rising by 10.8 per cent from a year earlier _ twice the pace of increase reported in October.

There were widespread increases in the price of fruit ranging from bananas, pears, strawberries and oranges. This may be due to the recent marked weakness in the pound, which drives up import bills. Most fruit in Britain is imported.

Overall food price inflation remained in double digits, at an annual rate of 11.7 per cent, although it eased from a peak level of 14.5 per cent reached in August.

In the meantime, other key inflation figures also signalled waning price pressures. The more popular Retail Price Index showed that annual inflation fell back to 3 per cent last month, its lowest since May 2006.

The sharper fall in RPI inflation came as these figures take some account of trends in house prices, as well as including mortgage interest payments which are falling in response to the Bank’s cuts in interest rates.

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