David Prosser: A bogeyman only in our imagination?

Just one problem. Inflation, as measured by the Consumer Price Index, hasn’t yet fallen below 1 per cent, which would trigger a letter of explanation about missed targets from the Bank to the Chancellor, let alone into deflation territory. Indeed, we learnt yesterday that inflation did not fall at all last month.

There are some good reasons for this. Not least, the Bank’s unprecedented monetary assault on the slowdown is paying dividends. One reason for the stickiness of inflation is an increase in house prices, which partly reflects an easing in the availability of mortgage credit. Also, a sharp depreciation in sterling has had a markedly inflationary effect on import prices, which may have artificially boosted July’s figures.

Still, the fact remains that halfway through the third quarter of the year, the three-month period at the end of which many economists expect the UK’s sharp recession to officially be declared over, we have not come anywhere near to seeing fears of deflation turn into a reality.

The question now is what that means for the future direction of monetary policy. A single month of flat inflation does not mean the decline is over for good, but we are beginning to think about a world in which interest rates at a record low and an extension of quantitative easing might not, after all, be necessary.

The expectation is that inflation will slow further during the autumn, because fuel prices were so much higher last September and October. That artificial blip, however, could be countered in December by an equally arbitrary factor, with VAT due to return to 17.5 per cent after a year at only 15 per cent.

From the new year onwards, the outlook is distinctly cloudy. Even with a slow pace of recovery, will there really be so much spare capacity in the economy that inflation continues to fall? If so, then the spectre of deflation may continue to cast a shadow ? if not, the Bank could even find itself worrying about inflation edging back up, which is what critics of quantitative easing have felt nervous about all along.

These are the judgements the MPC gets paid to make. Adam Posen, who joins the committee next month, said yesterday he hoped there would be no tightening of credit any time soon. Will he feel that way after three months in his post?

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