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Stockmarkets worldwide fell sharply yesterday as investors took fright at the extent of the global recession and the continuing problems in banking. An indication of the depth of the slowdown in the UK came as inflation on the retail price index tumbled last month to its lowest level since 1960.
The FTSE 100 share index closed down 2.5%, or 100 points, at 4,034, while the Dow Jones industrial average in New York dropped nearly 4% to close within a fraction of a point above the figure in November which set a five-and-a-half year low.
The pound saw some relief from its recent decline as investors fled to the currency after the euro was hit by a warning from ratings agency Moody's about the effects that a steep downturn in eastern Europe would have on banks in Germany, France, Italy and Sweden. The pound moved above 1.13 to the euro as a result.
In Britain, official data showed that deflation was about to become a reality for many wage earners. The retail price index, on which most pay deals are based, fell to 0.1%, the lowest level since March 1960, when it was -0.5%. The main reason for the fall was mortgage interest rate cuts following Bank of England base rate cuts.
That and falling petrol prices have dragged the RPI down from a peak of 5% in September. With this month's base rate cut from the Bank of England yet to feed through, the RPI is almost certain to turn negative next month.
Liberal Democrat Treasury spokesman Vince Cable said: "It is becoming clear that, for the foreseeable future, there is a higher risk of deflation than inflation, which is why it is inevitable and sensible that the Bank of England should be moving towards expansion of credit and the money supply directly."
Shadow chief secretary to the Treasury Philip Hammond said: "Falling prices are good news for struggling families in the short term. But what we need now is action to get credit flowing in the economy, to ensure that low inflation doesn't turn into a prolonged period of deflation - bringing with it the risk of turning a recession into a depression."
But other ONS data showed that the government's preferred consumer price index (CPI) measure of inflation, which excludes mortgage rates and house prices, only slowed slightly last month to 3%, from 3.1% in December.
That was another factor helping sterling on the foreign exchange markets, since it slightly dampened expectations of a rush to reduce the base rate further.
Within the CPI, prices of petrol and diesel fell 15.2%, the biggest drop on record. Petrol prices averaged 86.3p last month while diesel was 98.4p.
The City had expected the CPI to fall to 2.7%, but the cost of games, toys and furniture held steady in January after heavy discounting in the run-up to Christmas.
The collapse of Woolworths and furniture chain MFI helped to spur retailers to slash their prices in December, and retailers were reluctant to lower prices even further in January.
Although the CPI is still well above the 2% government target, economists expect it to drop sharply in coming months amid sliding commodity prices and a slowing economy, piling pressure on the Bank to take further action to stimulate the economy. The Bank is considering more drastic measures to get consumers and businesses spending again.
Bank governor Mervyn King said last week that the monetary policy committee would discuss "quantitative easing" - boosting the flow of money in the economy - when it meets to decide on interest rates next month.
The Bank expects CPI to drop as low as 0.5% this year and to remain well below its 2% target until 2012, even if interest rates are cut further. But many economists think it could drop below zero this summer.
The ONS figures showed gas and electricity suppliers have been slow to respond to the collapse in the price of oil. Electricity prices last month were 30% higher than a year ago and gas prices 50%. Heating oil prices, which are much more closely connected to diesel prices, are down 14%.
In the US, hopes for an early recovery receded as statistics continued to dash hopes that the economy would turn upward by mid-year. The New York Federal Reserve said yesterday that its regional index of manufacturing activity showed the sharpest contraction in February since it started the gauge in 2001.
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