The annual increase in UK consumer prices climbed further to 4.7% in August but retail price inflation slowed from 5.0% to 4.8%. The RPI measure will fall beneath CPI inflation over coming months. The gap between the two may exceed one percentage point by mid 2009 – the largest since 1993.

The chart shows my updated forecasts incorporating the latest numbers. Key assumptions include:

• Unprocessed food price inflation slows gradually from 13% in August to 2.5% by December 2009.
  

• Electricity / gas tariffs rise by a further 10% in September but energy prices are stable thereafter.
  

• “Core” CPI inflation – excluding unprocessed food and energy – slows gradually from recent rates, reflecting economic weakness and a fading impact from sterling’s depreciation.
  

• The housing depreciation component of the RPI, which tracks house prices, falls by 15% by mid 2009, stabilising thereafter. (The CPI excludes housing depreciation.)
  

• Bank rate is cut by half a point to 4.5% by the end of 2008, remaining stable in 2009.
  

On these assumptions, annual CPI inflation returns to the 2% target in September 2009. However, RPI inflation falls below 2% in June next year, reaching 1.1% in September. Of course, further Bank rate cuts during 2009 would imply still-lower RPI numbers.

While lower interest rates contribute, falling house prices are the key reason for the forecast RPI / CPI divergence. The housing depreciation component carries a 5.5% weight in the RPI so the assumed 15% annual decline in mid 2009 subtracts 0.8 percentage points from the annual RPI increase.

The coming plunge in RPI inflation will lower inflation expectations, subdue wage settlements and boost real income growth. It should also make it easier for the MPC to justify cutting Bank rate while CPI inflation is still above target. I expect the first move to occur as early as next month.