RTTNews - U.K. annual inflation dropped below the central bank's 2% target for the first time since September 2007.

After staying above 2% for 20 consecutive months, annual inflation eased to 1.8% in June from 2.2% in May. From May, consumer prices rose 0.3%, a report from the Office for National Statistics said Tuesday. Annual and monthly variations matched economists' expectations.

Core inflation that excludes energy, food, alcohol and tobacco was 1.6% in June, unchanged from the last month and in line with expectations.

Food and non-alcoholic beverages and furniture, household equipment and maintenance made a negative contribution to CPI, but large upward pressure came from the recreation and culture category.

Annual inflation measured by the Retail Prices Index, which includes housing costs such as mortgage interest payments and council tax dropped 1.6% compared to a 1.1% fall in May. This was the lowest RPI number since records began in 1948. The main factors affecting the CPI also affected the RPI.

The RPI stood at 213.4 in June versus 212.8 in May, representing a monthly 0.3% rise. The RPI numbers also matched economists' expectations. Excluding mortgage interest payments, the index rose 1%, slower than the 1.6% increase seen in May.

Citing the slowdown in inflation, British Chambers of Commerce Chief Economist, David Kern said inflation is a longer-term threat which must be dealt with by a credible exit strategy, but this can only be applied when the recession ends. He again urged the Bank of England to increase the scale of quantitative easing well beyond GBP 125 billion.

In an interview to the Yorkshire Post published Tuesday, the central bank deputy governor Charles Bean said the monetary policy committee is set to review the asset purchase scheme in its August meeting in the light of latest data on business activity and inflation projections.

Regarding the exit route, Bean noted that there are two ways, by raising bank rate and by reversing purchases - selling the assets back. It's most plausible to think that the first thing we will do is raise bank rate and then sell the assets back over an appropriate timescale in light of market circumstances.

Peter Dixon, Commerzbank's analyst said the most likely explanation for the apparent stickiness of inflation was the lagged impact of last year's sterling depreciation. He noticed the effect on commodity easing in recent months and expects the impact of a weaker currency to play less of a role in the months ahead.

Further, Commerzbank expects inflation to slow, reaching a trough below 1% by September. However, this effect would possibly prove temporary as the base-year effect derived from collapsing commodity prices will bottom out in the autumn.

RPI inflation is also expected to reach a trough around minus 2% by September. But as the negative effect from falling mortgage costs starts to fade from the indicator, it might enter positive territory on this measure by year-end.

The central bank expects inflation to stay below target in the coming few years.

Earlier in the day, two separate surveys indicated that the fall in U.K. house prices are expected to continue for some more time, despite tentative signs of recovery. According to the Royal Institution of Chartered Surveyors or RICS, the house price balance rose to minus 18.1 in the three months to June.

Professional services firm PricewaterhouseCoopers said, with mortgage lending and housing transaction levels remaining subdued and with unemployment likely to continue rising for some time, average British house prices are likely to fall further between 2009 and 2010.

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