The fall in annual CPI inflation to 1.1% in September reflected energy base effects and lower food prices and was in line with a forecast presented in an earlier post. Inflation is likely to climb sharply over the next few months, with a risk that it breaches 3% in January, necessitating an explanatory letter from Bank of England Governor King to the Chancellor

At the August Inflation Report press conference, Mr King stated that it was "more likely than not" that he would have to write a letter explaining an undershoot of 1% later in 2009. Because of the favourable energy base effect, any such shortfall was expected to occur in September. With the odds in favour of a rebound in October and beyond, an undershoot letter is now unlikely.

Despite the fall in September, inflation averaged 1.5% in the third quarter, comfortably above the Bank's forecast of 1.3% made just two months ago. Coupled with the recent plunge in the exchange rate, this should lead the Bank to revise up its near-term projections once again in the November Inflation Report. It currently forecasts average inflation of 1.3% and 2.1% in the fourth and first quarters.

While the 1.1% September outturn is well below the 2% target, the shortfall is entirely explained by lower energy costs and last December's VAT reduction. Core CPI inflation – excluding energy, food, alcohol and tobacoo – was 1.7% last month and would probably stand at 2.3-2.4% in the absence of the VAT change (based on official estimates of its impact).

The Bank, like the consensus, thought CPI inflation would fall by much more than it has this year – the May Inflation Report projected a drop to just 0.4% in the fourth quarter. Forecasting models gave too little weight to the impact of sterling's decline while placing overreliance on highly-uncertain estimates of the "output gap" and its influence on pricing decisions. (These issues were discussed in a post in March.)

With CPI inflation overshooting its projections, and the core VAT-adjusted rate above the 2% target, today's numbers do not warrant a further expansion of the Bank's quantitative easing programme next month. As argued in a post last week, there is evidence that the Bank's gilt-buying is creating excess liquidity in the economy and a further monetary injection could lead to an accelerating decline in the currency.