June factory costs in UK fall sharply

Factory costs fell last month at their sharpest annual rate since 1997 and output prices dropped at their fastest in seven-and-a-half years, suggesting inflation will fall sharply in the coming months.

The Office for National Statistics said output prices - of goods leaving the factory gate - fell 1.2 per cent year-on-year, the sharpest drop since December 2001 and more than the 0.8 per cent fall expected by analysts.

Input prices fell 11 per cent on the year, less than forecasts for a 12.2 per cent decline but still the weakest annual rate since April 1997.

"My sense is that given the increase in crude oil prices, input prices will climb again," said Amit Kara, economist at UBS. "Output prices will stay under pressure in the immediate future because of the economic slowdown."

Inflation went up sharply last year because of record high energy prices but Bank of England policymakers are expecting it to come down just as swiftly in the coming months as Britain battles its deepest downturn in decades.

The central bank has slashed interest rates to a record low of 0.5 per cent and launched an unprecedented £125 billion asset purchase scheme to get money flowing through the economy again to kick-start a recovery.

Recent surveys have suggested conditions are starting to stabilise and the Bank shocked markets this week by not expanding its quantitative easing programme, prompting concerns it is preparing to start winding down its stimulus to the economy.

The central bank's new forecasts for inflation and growth in August hold the key to the future of the programme and analysts said policymakers were probably right to want to tread cautiously until they have that information.

The path of inflation going forward is unlikely to be smooth as a recent pick-up in oil prices puts upward pressure on inflation in the near term and beneficial base effects from rising oil prices last year will soon subside.

On the other hand, weak demand is likely to keep up the pressure on manufacturers to lower prices.

Latest data showed output prices excluding the volatile components of food, drink, tobacco and petrol, rose just 0.1 per cent on the year - a five-year low.

"Any sign that deflationary pressures are broadening out will be a cause for concern for the Monetary Policy Committee, particularly as spare capacity will put downward pressure on prices and margins over the next eighteen months or so," said Colin Ellis, economist at Daiwa Securities.