Cheaper food, reduced prices for computer games & smaller increases in the price of clothing & shoes contributed to a fall in the cost of living rate from 4.4% to 4%

The latest figures from the Office for National Statistics this week show the first fall in the annual inflation rate since last July. It had been highly anticipated that inflation would creep towards the 5% mark over the coming months fueling the possibility of an early rise in interest rates when the monetary policy committee next meet to determine the Bank of England interest rates in May.

“These figures should help to sound the death knell for a May rate hike, especially given the current woes on the high street,” said Philip Shaw, economist at Investec.

But Andrew Goodwin, senior economic adviser to the Ernst & Young Item Club, said: “These figures represent a massive surprise on the downside and will no doubt be greeted with relief by the majority of the MPC. Indeed, with the MPC having forecast an inflation rate of 4.1% in Q1, for the first time in quite a while their forecast won’t be out of date within a couple of months of being published.

“We may still see CPI inflation edge up further over the months ahead, as the effects of further rises in oil prices feed through. But the dreaded 5% rate that we had once feared now looks a fair way off and is unlikely to be realised. That said, this doesn’t alter the fact that households will still see a substantial fall in their real incomes throughout this year – this just eases the pressure a little.”

News of the fall in inflation rates follows on from the report that The International Monetary Fund (IMF) has cut its 2011 growth forecast for the UK economy to 1.75%, its third downgrade in a year – a result of spending cuts it regards as necessary having a dampening effect on consumer demand.

Figures released from British Retail Consortium – BRC – last week show that Britain’s retailers are experiencing the toughest trading conditions for at least a decade and a half as a result of curtailed consumer spending.

In a recent interview given to the Guardian, Adam Posen – external member of the Monetary Policy Committee at the Bank of England – is predicting that inflation will drop dramatically by the middle of next year.

Posen is convinced that consumer spending is likely to be curtailed as a result of the coalition’s austerity measures combined with the weak economy. He reckons that the temporary effects of the increase in VAT, & the increased costs of fuel & food will level off resulting in the rate of inflation dropping back to below the government’s target of 2% by the second half of next year. “Household consumption is going to be pretty darn weak. It may even contract a little”, he said.

This stance taken by Posen very much echoes the views expressed by the governor of the Bank of England – Mervyn King – in recent speeches & documents.

Posen talked about how he has repeatedly voted for quantative easing & for the interest rate to be held at 0.5%, convinced that it is the right thing to do. He said:  ”If I have made the wrong call, not only will I switch my vote, I would not pursue a second term. They should have somebody who gets it right and not me. I am accountable for my performance. I’m holding my nerve because it is the right thing to do.” He added:  ”It would not just be terrible that I had messed up for other people but it is also my fundamental world view that I have been testing.

“I would take it deeply and personally, which is why I have laid awake at night thinking about it.”

Posen said he took issue with the view that because interest rates at 0.5% had been cut to their lowest ever level since the bank was founded in 1694 they should be returned to a ‘more normal level’.

“If I am a firefighter fighting a fire I don’t say I have pumped more water than I have ever pumped in my life so I must have pumped too much. You stop pumping when the fire is out.”

Many experts believe – as Posen does – that the increase in taxes and public spending cuts will naturally lead to a fall in inflation, & feel that a rise in interest rates is unlikely in these circumstances. However external influences such as the earthquake & tsunami in Japan, the crisis in Libya, & unrest in Egypt will need to be factored in to predictions regarding the UK economy.

The next decision on interest rates by the MPC will be announced on Thursday (7 April). Three members of the Monetary Policy Committee – Andrew Sentance, Martin Weale and Spencer Dale – are known to have voted for higher interest rates earlier this month. Experts say the decision will be close but do not envisage a rise.

Mervyn King – the governor of the Bank of England – has always expressed his opinion regarding the Bankers’ role in the recent financial crisis.

Giving evidence to the House of Commons Treasury committee, King once again risked the wrath of the financial services sector as he blamed them for the necessity of the government’s planned spending cuts. He said that people who had lost their jobs & businesses as a result of the crisis had every reason to be angry & he was surprised that there wasn’t more anger being expressed by the public.

“The price of this financial crisis is being borne by people who absolutely did not cause it,” he said. “Now is the period when the cost is being paid, I’m surprised that the degree of public anger has not been greater than it has.”

Questioned regarding lending by the banks to the economy he responded: “The figures are clear — the banks are delivering a negative volume of net lending. Credit conditions have improved for big companies, but there’s little sign that the situation has improved for small and medium-sized firms. I understand why the people running those companies still feel under great pressure.”

During the hearing it was evident that it is the opinion of the members of the monetary policy committee of the Bank of England – the body responsible for setting interest rates – that the crisis will have a long lasting impact for the UK economy.

Asked by one MP when living standards would recover King responded by saying: “The research makes it clear that the impact of these crises lasts for many years. It is not like an ordinary recession, where you lose output and get it back quickly. We may not get the lost output back for very many years, if ever.”

King also said that while a “squeeze on living standards is inevitable, that the distribution of the pain is a political choice”.

When questioned on inflation he King once again stated that raising interest rates as a gesture of the Bank of England’s anti-inflation resolve would be self-defeating.

As the session came to an end King announced that it was the 20th anniversary of his joining the Bank of England & that he could never have imagined the events that have occurred in Britain over the last few years. He concluded by saying, “I don’t intend to leave until we have persuaded this committee that we have a framework in place to ensure that such a crisis cannot happen again.”

In a sharper than expected fall its been announced that the UK economy shrank by 0.6% in the final quarter of 2010

The revision was said to be due to worse than expected performances from industry & service sector firms which fell by 0.7%. Consumer spending also fell & it was only the higher levels of government spending that balanced the shrinking economy by contributing growth at a rate of 0.7%. The Office for National Statistics has continued to maintain that 0.5%of the decline was due to the harsh weather conditions in December – the coldest on record.

The figures are particularly concerning given the huge cuts in government spending which are about to be implemented.

The shadow chancellor – Ed Balls – criticized the government’s plans to cut the deficit: “2011 should be the year when the British economy grows strongly and the recovery is secured. Yet the early signs are that the Tory-led government’s reckless decision to abandon Labour’s plan to halve the deficit over four years has seen the economy take a turn for the worse.

“We now face the worst of all worlds – unemployment and inflation both rising, growth stalled and consumer confidence collapsed. And this is before the government’s extreme fiscal tightening really starts to bite.”

Brendan Barber – general secretary of the TUC – said: “The government’s hope of an upwards revision of growth has been dashed. It’s time to wake up and smell an economy in big trouble. We need a plan B that doesn’t send it over the edge with deep rapid spending cuts.”

Despite the many concerns expressed, the treasury reiterated its determination to tackle the budget deficit, a spokesman for the Treasury saying: “The chancellor said that the fourth-quarter growth figures were disappointing and today’s revision doesn’t change that fact. It also doesn’t change the need to deal with the nation’s credit card – the country is borrowing more this year than is spent on the entire NHS.”

The new figures once again draw attention to the duality of issues facing the monetary policy committee of the Bank of England over interest rates. It is now clear from the minutes that three members voted for higher rates at February’s meeting, with one member calling for more quantative easing.

Vicky Redwood – senior UK economist at Capital Economics – said, “The slight downward revision to UK GDP might give the more hawkishly inclined members of the MPC reason to pause for thought,”

The Bank of England has kept its base rate at 0.5% for the 23rd month amid fears that a rise was imminent.

Many had thought interest rates might rise because of the continuing escalation in the rate of inflation, with economists estimating the likelihood of a rise at 20%. Charles Bean – deputy governor of the Bank of England said last week that the MPC may have no choice but to raise the cost of borrowing if food & commodity prices continued to rise at their current rate.

The Monetary Policy Committee (MPC) has an inflation target of 2% & it is expected that figures due out next week will confirm that inflation went above 4% in January with the possibility of it approaching 5% before the summer. For some time now one of the members of the MPC – Andrew Sentence – has been urging the committee to raise rates to pre-empt businesses from raising prices & workers from making increased wage demands which could lead to inflation becoming entrenched. The newest recruit to the committee – Martin Weale – last month supported Sentence in urging the committee to a rise in interest rates to 1%. It is thought likely that other members may have joined them when voting on this recent decision took place.

The counter argument to raising interest rates, & one strongly put forward by Mervyn King – Governor of the Bank of England – is that to do so would weaken the already faltering economic recovery from the recent recession. He feels that even a small rise in interest rates would be detrimental to economic recovery at a time when both businesses & homeowners require cheap borrowing & is bent on keeping interest rates low. He points out that it is anticipated that the rapid rise in food & commodity prices will ease off by next year & states that much of the current inflation is due to the VAT hike to 20%

Shortly after the decision to maintain current interest rates, the latest estimates for growth in January confirmed that the UK economy is still very weak. Its recovery is also in jeopardy due to the announced government spending cuts.

It continues to remain unclear when interest rates will eventually begin to rise. Some analysts predict this may be as early as May with the MPC having no choice but to attempt to combat inflation regardless of their concerns for the economy. Many economists such as Stephen Boyle, head of RBS group economics suggest August as the starting point & others  even later in the year.

One economist – Roger Bootle – adviser to the accounting firm Deloitte put an even longer time scale on the move: ‘Given the huge amount of uncertainty about the underlying strength of both economic growth and inflation, the committee would be foolish to rush into a premature tightening of policy. Indeed, as the fog clears, it should become clear that interest rates need to remain at an ultra-low level indefinitely,”

The US unemployment rate has risen above 10% for the first time in 27 years, leaving the US in a state of despair.

President Barack Obama will hold a jobs summit on Thursday, focused on job creation.

Although he has included business leaders amongst the 130 experts attending the summit in Washington, Republicans in Congress will opposed to any major spending plans.

President George W Bush has already frustrated them by spending billions on bailing out the banks and car makers.

The “big government” image and creating big financial defecits to be paid for by future generations are unpopular in Washington.

Economy.com’s Mark Zandi believes deficits are a major worry, but we can’t afford to be concerned about it now.

“That’s a problem not for 2009, not for 2010. That’s a problem for 2011, 2012 and beyond,” he says.

“We have to make sure that we don’t go back into a recession, because if we go back into recession, the cost to taxpayers will be even greater.”

“The deficits will be measurably larger, so I think it’s important to spend more money now.”

According to Mr Zandi, government spending needs to be aimed at assisting local government offices, as with tax funding falling, many employees are at risk of losing their jobs.

President Obama is on the look out for new ways to combat unemployment.

Unemployment benefits usually run out after six months in the US, but have been extended because of the highest unemployment rates.

Mr Zandi believes continuing with providing benefits to the unemployed as essential to maintaining demand, as those with no money make no purchases.

That situation could develop into a ‘catch-22’, downward spiral, as consumers that don’t consume, results in businesses cutting their workforce, causing more unemployed with no money to spend.

Another area where Mr Zandi feels the government can make a unique contribution is providing credit to small and medium-sized businesses.

Banks are still cautious over lending after the credit crisis, but have always given capital to start-up companies to help them expand, and these new businesses usually provide America with the majority of new employment.

Mr Zandi believes that “it’s clear that even when the economy gets back on its feet, we’re going to have very high unemployment in many parts of the country for a long time to come.

“One reason is that the people out of work don’t have the skills and education necessary to be employed in the jobs of the future.”

Plans to split British bank Northen Rock in two which would allow for its partial sale has been granted by the European Union.

The divide would result in two separate banks forming and are already being described as the “good” and “bad” banks.

The “good” bank would offer new lending, retain some of the existing mortgages and hold its savers’ money.

The “bad” bank would be used to repay the existing government loans and hold the remaining loans.

 Decisions made by the EU to accept the move are seen by Northern Rock as “an important and positive step.”

Changes to the existing setup will be made towards the end of the year.

The EU revealed that the good portion of the bank would be expected to grow and then be sold to third party, with the bad bank allowing its assets to dissolve then becoming liquidated.

The good bank may be sold prior to the general election next year with potential buyers being speculated already, with Virgin and National Australia Bank, owner of Clydesdale and Yorkshire Bank, among the interested parties.

EU Competition Commissioner, Neelie Kroes, believes that the move would make the bank a good long-term option, revealing that “this decision demonstrates once again that the EU’s state aid rules provide an appropriate framework to allow state support for a sustainable restructuring of banks without giving individual banks an unfair competitive advantage.”

Whilst Jonathan Todd, European Commission spokesman, said caps would need to be applied for the duration that the good bank remains owned by the public.

Some of the caps include a balance sheet reduced to a quarter of its size prior to the crisis, not being the market leader for loan interest rates, a cap set to limit its lending to one-third of Northern Rock’s 2008 levels and also a cap on retail deposits to be slightly lower than the pre-crisis level.

An investigation was engaged by the EU into Northern Rock in April 2008, two months after its nationalisation.

The results from the investigation showed that the UK government was kept at a “necessary minimum”.

By 30 June, the bank had paid back approximately half the taxpayers’ £26.9bn loan and will gain a further £8bn from the government during the end of year restructuring.

The EU stated that the restructuring would reduce its market share to below half of its pre-crisis level and “correct the excessive expansion of Northern Rock pre-crisis.”

Northern Rock released a statement, saying “this approval is an essential requirement of the planned legal and capital restructure, which is central to the business plan for Northern Rock.”

“The restructure will strengthen the capital and liquidity position of Northern Rock significantly, and offers value for money to taxpayers” and it would be “business as usual” for its customers.

According to official figures, the UK experienced an unexpected contraction of 0.4% for the third quarter, showing that the UK is still stuck in the recession.

This quarterly contraction is the sixth consecutive contraction, the worst run of figures that UK gross domestic product (GDP) has experienced since records began 54 years ago.

The GDP of a country represents the value of goods and services produced by a country. The figures released may be altered at a later date, as this is just a first estimate.

The Office for National Statistics (ONS), had been expected to show quarterly growth of 0.2%. However, no growth in retail sales for September and a 2.5% fall in industrial output for August had dented people’s positive expectations.

Experts have revealed that one of the main causes of the contraction was an unexpected drop in the services sector, with distribution, catering and hotels generating some of the worst figures.

Nearby countries France and Germany exited the recession earlier this year, and it is generally considered that the UK’s reliance upon the services sector, and more specifically, the finances sector being the main reason.

The UK economy has now experienced a 5.9% contraction since its high point prior to the recession.

The Bank of England is set to re-think its quantitative easing plan after seeing such a poor result in GDP figures. Quantitative easing involves the Bank of England printing money to buy bonds from companies and banks in an effort to encourage positive activity in the economy.

HSBC’s Bronwyn Curtis spoke with the BBC, revealing that “back in August we had a worse-than-expected second-quarter GDP number and that is the reason that the Bank of England extended the quantitative easing programme,”

ING’s James Knightly felt that the data was “awful with no positive news” and “clearly suggests that the likelihood of an expansion in quantitative easing by £50bn or so over the next quarter is rising, although [it] is not a foregone conclusion.”

It is considered by many experts to be disturbing that measures taken by the government and the Bank of England have failed to make a positive impact. However, David Kern, the chief economist with the British Chamers of Commerce believes that “continued intervention – including help for businesses to access finance, and incentives to promote investment – is still needed.”

“Above all else, business confidence must be nurtured, to ensure that recovery is not further delayed.”

Alistair Darling has announced that the government must borrow its way to recovery and believes that it’s the best avenue for the UK economy in the long run.

The Chancellor of the Exchequer confessed that further national borrowing “may feel counter-intuitive,” but “will mean the bills we face as a country are lower” in the long run.

However, many believe that the levels of government debt are already too high, with cuts in public spending and tax rises required. The government has already raised borrowing during the recession by high amounts.

Following Mr Darling’s speech, a question-and-answer session was held, with the chancellor finding agreement with Mervyn King, the Bank of England Governor, stating that there were “no simple answers” when it came to the reform of big banks.

According to Mervyn King, their core business may need to be divided into other practices to prevent them from becoming so big that they aren’t allowed to fail.

Mr Darling was concerned that “we cannot have a regulatory regime that excludes the possibility of failure.”

He went on to state that the banking sector needed more competition, and when the government came to selling its bank stakes that were bought during the financial crisis, it would be hoping to develop greater competition.

Many are calling for a reduction to the borrowing and spending that has caused so much debt, but Mr Darling believes that withdrawing government support would be “wrong and dangerous,” and the country would have to make a big decision.

At a speech in London, Mr Darling declared that “we can resign ourselves to a decade of austerity, low growth and low employment, or we can embrace change, turn it to our advantage and seize the huge opportunities a global recovery will bring.”

He continued by warning that withdrawing government support to the economy “would put the recovery at risk and abandon people facing unemployment.”

In a bid to encourage demand during the recession, the government has pushed billions of pounds into the economy through its £175bn quantitative easing plan, cut the VAT rate and helping ailing banks.

According to Mr Darling, a great deal of work was still required to steer the country out of the recession, including three big steps.

“First, we must support the economy until we’re sure the recession is over. Some are tempted to think the crisis is over. It’s not. Banks all over the world are still dependent on government support.”

The second step would involve raising taxes to regain financial strength and taking “tough choices on public spending for the years ahead”.

He added, that it “will mean cutting costs, cutting waste and cutting lower priority budgets, while continuing to invest in our priorities and our future.”

His third step would involve a government plan of growth.

“We need growth, because when we grow, the economy becomes bigger, we all become richer as a country, and it gets easier to pay back debt.”

Whilst the general financial atmosphere is improving and optimism growing, it is too soon to announce that we are in the process of recovery, according to experts at Ernst and Young Item Club.

The influential professional services firm expects some growth towards the end of 2009, but this growth should begin to struggle, with 1% expected growth for 2010.

They also predicted that customers repaying debt will grow slower than first anticipated and impending tax rises will follow the election.

BT Business research predicted a more optimistic outlook, declaring that small businesses are positive about the forthcoming year.

In September, BT Business conducted a survey of over 7000 small businesses and found that 75% believed their business would see an upturn in 2010, with 61% confident about their business’ prospects.

Professor Peter Spencer, Chief Economist from the Item Club, issued a wake-up-call to all those getting carried away with the optimism of recovery.

He warned, “there could still be substantial pain to come for corporates and consumers.”

“For a sustainable recovery the UK economy needs world trade to pick up and there is still not much sign of that happening.”

One of the factors holding back growth is that the VAT rate will return to 17.5% from its current level of 15% on 1 January, a change which may see consumers making purchases before the New Year.

Several other factors which will hold back growth lie on the horizon. An increase in national insurance contributions, the new 50p tax rate, the termination of the car scrappage scheme, tighter government spending and the return of stamp duty on housing are all due to hit the country.

Judging whether the recovery is happening, on the way or unlikely is difficult to forcast.

Professor Spencer went on to tell the BBC that the recent economic data has been “very mixed,” adding, “the stock market is absolutely rampant, industrial surveys all back in positive territory, but it’s yet to show through in hard data for output and things like that.”

“And when it comes to lagging indicators like unemployment, I’m afraid it’s going to be ‘feel bad’ for quite some time to come.”

On Friday, the official statistics for the Gross Domestic Product (GDP) are released, with many expecting no economic growth at all.

GDP is a measurement of the services and goods produced in a country, and since the first quarter of 2008, the UK GDP has been in negative figures.

The Bank of England has focused on quantitative easing, an act of pushing money into the economy. Professor Spencer feels that this has been of little success, with the little improvement on bank lending, going on to complain that “instead, the banks appear to have used much of the money to rebuild reserves and improve liquidity.”