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UK inflation rate drops amid ratings downgrade threat

Published:Wednesday | February 15, 2012 | 12:00 AM

Britain's inflation rate fell to 3.6 per cent in the year to January from 4.2 per cent the previous month, official figures showed Tuesday.

The news comes a day after ratings agency Moody's cut its outlook on the nation's AAA credit rating from "stable" to "negative" - the government has prided itself on using aggressive austerity to maintain investor confidence and its top credit rating.

Late Monday, Moody's Investor Service downgraded the ratings of Italy, Portugal and Spain, and warned that it may cut its AAA ratings of the United Kingdom as well as France and Austria.

The inflation data released by the Office for National Statistics was in line with expectations and put inflation below four per cent for the first time since December 2010. A fall in fuel prices helped, as did the fact that last year's sales-tax hike dropped out of the annual comparison.

The UK consumer price inflation rate peaked at 5.2 per cent in September.

Bank of England Governor Mervyn King said inflation is likely to be near the two per cent target by the end of the year, although "the pace and extent of the fall in inflation remain highly uncertain".

"The unwelcome combination of sluggish growth and high inflation over the past two years is a reflection of the need for the economy to rebalance following the financial crisis and associated deep recession, together with rises in the costs of energy and imports," King said in a letter he is required to write to the government every quarter in which inflation is more than one percentage point above or below target.

"Although inflation is now falling broadly as expected, the process of rebalancing still has a long way to go. Growth remains weak and unemployment is high."

In its report on Britain's credit rating, Moody's Investor Service said the UK economy remains vulnerable to a deterioration in European economic and financial conditions.

Though inflation has been running above the two per cent target since December 2009, rate-setters have kept borrowing costs at the record low base rate of 0.5 per cent and recently approved another monetary stimulus in response to falling output - recent figures showed the UK economy contracted 0.2 per cent in the last three months of 2011.

The central bank has held its policy line despite elevated inflation rates, arguing that price pressures would diminish this year. Markets will be interested to see if Wednesday's quarterly economic projections from the Bank of England show inflation falling below target later this year.

Many economists think that's a distinct possibility and that the bank will back even more stimulus in the months ahead.

Last week's announcement that the bank will be splashing out another £50 billion (US$79 billion) in asset purchases raised the total monetary stimulus since the programme started in March 2009 to £325 billion.

- AP