Will U.K.'s Inflation Rate Finally Temper in 2012?

Unless you've been living under a rock, you'd know that inflation has been a big problem in the U.K. for this year. Inflation in the U.K. has been as stubborn as a 6-year old boy who doesn't want to take a bath after playing in the mud outside!

To U.K.'s credit, their central bank didn't just sit idly by and watch prices soar. The Bank of England (BOE) has done practically everything they can - from cutting rates to near zero at 0.50% to implementing QE - to stoke inflation, yet nothing worked!

Since unemployment remains high and growth is weak, talks of the economy falling into stagflation (stagnant growth but high inflation and unemployment) have been making rounds in the market.

Despite all these, the BOE insists that inflationary pressures will be subdued in the long-run. Central bank officials believe that the slack in their economy brought about by spare capacity and weak demand would eventually drag price levels down, and they do have a good point. After all, businesses are likely to bring prices down in order to pump up demand for their products.

Besides, it can't be denied the U.K. labor market isn't exactly on the up and up. Their jobless rate currently stands at 8.3% as the number of unemployed people hit its 17-year high of 2.64 million.

With this downturn in hiring, Britons are less likely to spend. Add to that the fact that high unemployment leads to slower wage growth, sometimes even a decline in wages, which would also dampen demand.

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Based on these, it appears that the BOE was spot on in predicting that inflation would slow down, even though it took quite a while.

Their annual CPI has actually dropped over the past couple of months from 5.2% to 4.8% and if this trend continues, the BOE's forecasts could actually be realized. BOE member Spencer Dale even predicts that the inflation rate could taper down to as low as 3.0% by March next year.

The British economy could benefit from this as lower price levels could encourage more people to spend, consequently driving up demand. In effect, businesses would have to increase production to meet the rising demand.

Of course, this would require more workers so companies would have to step up their hiring as well, leading to an uptick in employment.

While it seems that it will all end happily ever after for the U.K., don't forget that there are still plenty of economic challenges on the horizon. Let's wait and see what the future holds for the British economy!