Inflation falls to lowest level for six years

FALLING mortgage rates pushed the annual rate of inflation down to 2.6 per cent in December - the lowest for more than six years - and brought the prospect of the headline rate falling close to 2 per cent this month.

The figures prompted fresh speculation that the Chancellor, Norman Lamont, would cut base rates around the time of his Budget on 16 March. The reduction from the current level of 7 per cent could come even earlier if a cut in European rates, led by Germany, emerged in the next few weeks as the market increasingly expects.

Some analysts predicted that headline inflation would briefly edge below 2 per cent in the next few months for the first time since November 1967. Yesterday's December figure meant that headline inflation averaged 3.7 per cent in 1992, down sharply from the 5.9 per cent average in 1991.

The outlook for further falls in the inflation rate was helped yesterday when National Westminster Bank joined a growing trend towards below-inflation pay awards. It said it wanted to impose a freeze on basic pay for its 70,000 staff from April, a move which its union said could provoke industrial action.

Excluding mortgage interest rates, the underlying rate of inflation edged up by 0.1 percentage points to 3.7 per cent after an unexpected rise in prices of seasonal food. This is similar to the comparable measure for West Germany last month and in line with the European Community average for November.

Anthony Nelson, Economic Secretary to the Treasury, yesterday declared that the Treasury was 'absolutely determined' to ensure the measure remained within its formal target range for this year of 1-4 per cent - implying that a sustained breach of the upper limit would provoke a rise in interest rates.

City analysts are beginning to discount fears that the sharp devaluation of the pound after the exit from the European exchange rate mechanism in September would drive inflation up. They said they expected the fragile level of demand among consumers to force manufacturers and retailers to hold back price increases stemming from higher import prices. Profit margins may be rebuilt only when demand recovers sufficiently - a development unlikely to occur until later this year when the Treasury's ceiling for underlying inflation may be threatened.

Prices last month fell by 0.4 per cent as lower mortgage rates, reduced prices for second-hand cars and Christmas discounts for alcoholic drinks overwhelmed a rise in prices of seasonal food, tobacco and household goods.

Inflation this month and in the near future is expected to be suppressed by further cuts in mortgage rates, lower prices for gas, clothing, footwear and furniture, and sharp cuts in petrol prices.

But price increases already announced for travel on British Rail and London transport, as well as telephone rental charges and probable rises in the prices of seasonal food, alcoholic drinks and car insurance will foster upward pressure on inflation.

The NatWest pay freeze follows the example of a growing number of manufacturing companies. According to Income Data Services, 19 per cent of UK manufacturers imposed freezes for the year starting August 1992, compared with 9.9 per cent for the year starting August 1991. Rover, the car group, currently has a six-month pay pause which lasts until May 1993.

The announcement by NatWest came at the start of the pay round in the industry and other financial institutions are expected to adopt a similar policy.

----------------------------------------------------------------- Table: RETAIL PRICES DECEMBER ----------------------------------------------------------------- Percentage change over 12 months Seasonal food -9.9 Non-seasonal food +2.7 Alcoholic drink +5.0 Tobacco +9.1 Housing +0.5 Fuel and light -0.5 Clothing and footwear -1.1 Leisure services +5.9 Fares +5.5 ----------------------------------------------------------------- Source: CSO -----------------------------------------------------------------