Why falling inflation matters

Inflation is yesterday's problem. That was the clear message from the latest figures from the Office for National Statistics showing a bigger-than-expected drop in price pressures last month. Cheaper petrol and a seasonal fall in air fares meant the annual increase in the cost of living came down from 2.8% to 2.4% in April.

Belatedly, this starts to bring the UK into line with a more marked disinflationary trend in the rest of Europe. The depreciation of sterling since the start of the financial crisis has made Britain more vulnerable to imported price increases, but inflation as measured by the consumer prices index has now fallen by more than half since its peak. What's more, the good news is likely to continue. While there may be a short-term pick up in inflation as last year's falls in oil prices drop out of the calculations, the weakness of producer prices suggests there is little inflationary pressure in the pipeline.

The better news on inflation matters for two reasons. Firstly, it eases the squeeze on consumer real incomes by reducing the gap between price increases and wage increases. Note, however, that there is still a gap between what individuals are earning and the price of goods and services they are purchasing; it is just that this gap is getting smaller. The TUC published research on Tuesday showing that average salaries are worth £2,234 less than in May 2010 – a drop of 8.5%.

Unless and until real incomes start to rise, Britain's economic recovery will remain tepid. That will require a combination of further falls in inflation and a pick-up in wage growth. The former looks highly probable, the latter far less certain.

The second reason to welcome the fall in inflation is that it provides the Bank of England with more scope to ease monetary policy should the need arise. The six members of Threadneedle Street's monetary policy committee voting against further quantitative easing have advanced three reasons for doing so: they are dubious about the benefits of more electronic money creation; they think the economy is further on the road to recovery than the official data indicates; and they are worried that inflation has remained above its 2% target for more than three years.

Tuesday's figures will help deal with the last of those concerns, and will make it much easier for Mark Carney to push for further stimulus when he takes over at the Bank in July.