Record drop in inflation predicted

Britons are looking to softer price pressures next year after a Bank of England survey showed a record fall in inflation expectations.

The average inflation rate expected over the next year is 2.8 per cent, compared with 4.4 per cent in August - the biggest quarterly drop in the nine-year history of the Bank's attitudes study.

The fall will calm nerves among rate-setters that the recent spike in inflation could become entrenched in higher pay demands - leading to a damaging wage-price spiral.

But fears over job losses are set to curb wage demands and experts predict the official inflation benchmark could turn negative in 2009 - representing deflation - when the figures show big falls in oil and food prices.

More than 2,000 people surveyed in November put the current inflation rate at 4.9 per cent - slightly above the Bank's Consumer Prices Index benchmark, which stood at 4.5 per cent in October.

IHS Global Insight economist Howard Archer said: "The sharp fall in inflation expectations was clearly influenced by the plunge in oil prices from their July highs, which is particularly evident in significantly lower petrol prices.

"Respondents are also likely to have been influenced by the ever increasing discounting and sales being seen on the high street as increasingly struggling retailers battle to get consumers' dwindling business."

The Bank has already slashed interest rates from 5 per cent to 2 per cent since October - equalling the all-time record low - in a bid to stave off the worst impact of recession.

Sharply falling inflation expectations removed another hurdle and allowed the Bank to cut interest rates further still, Mr Archer added.

Almost 40 per cent of respondents expect borrowing costs to fall over the next year, compared with 10 per cent in August. This was also the highest in the history of the bank's survey.

Despite the recent drastic cuts, 41 per cent of respondents said interest rates had actually risen over the past year.

Although this was below the 63 per cent reporting higher rates in August, the relatively high proportion could reflect the sluggishness of some banks in passing on reductions in official Bank rate - as well as lenders repricing mortgages more expensively to rebuild finances battered by the credit crunch.