Inflation index 'blocks a cut

A seemingly minor change in Gordon Brown's 2003 pre-budget report to the way Britain targets inflation may be blocking cuts in interest rates, economists believe.

The change was from the old retail prices excluding mortgage interest (RPIX) to the consumer price index (CPI), ostensibly bringing Britain into line with other countries, especially the eurozone. The Bank of England's inflation target was lowered from 2.5% to 2% to allow for the fact that over the long run CPI has been about half a percentage point below RPIX.

But, as of August, RPIX fell below CPI for the first time since 1992, largely because of the rapid slowdown in house price inflation, which is excluded by CPI.

CPI is now above its target rate, at 2.4%, while RPIX is below its old target, at 2.3%. City analysts who predict the monetary policy committee will not cut interest rates again soon cite the fact that the CPI is moving above target. But if the Bank was using RPIX, there would be no such impediment to cutting rates again.

"It is possible people took their eye off the ball on this issue. They assumed the target had been slightly loosened but it is no longer clear that is the case," said CSFB economist Robert Barrie. He expects further house price falls in the coming months to maintain the unexpected disparity between the two measures.

Jonathan Loynes, economist at Capital Economics, said: "There is now the clear possibility that interest rates will be rather higher than they would have been under the old RPIX target."