Inflation fall eases rate pressure

UNDERLYING inflation in Britain fell to 1.8% in May, undershooting economists' expectations and calming fears of a rise in interest rates next month. The Office for National Statistics said retail prices, excluding mortgage interest payments, fell from 2.3% in April to their lowest since November and matched the lowest since records began in their present form in 1975.

Meanwhile, the all-goods retail price index showed a year-on-year fall to 0.9% last month, another record low. The ONS said this was due to falls in seasonal food prices and and a 4.1% drop in petrol and oil prices. Food prices soared in May last year due to weather damaged crops while gas prices were also higher in 2001. Tobacco was 1.4% up following duty rises in the recent Budget.

Housing costs had the largest upward effect on prices. Mortgage payments rose slightly in May compared with a fall in April last year in the wake of an interest rate cut.

Economists, who had pencilled in 2% today, said the low figures swung the argument back in favour of keeping interest rates on hold next month. The Bank of England has left interest rates at 4% for seven months but it has recently come under pressure to up the rate to rein in spiralling house prices.

Philip Shaw, at Investec Henderson Crosthwaite, said the figures were significantly better than expected and may call into question whether the monetary policy committee, under Bank of England Governor Sir Edward George, will raise interest rates at its July meeting. He added: 'This really is a volatile economic environment and the outlook for monetary policy is unclear. Clearly there are no inflationary pressures.'

Sterling reacted by hitting a 17-month high against the dollar at $1.4863 and 63.79p to the euro. Shares were marked down again with the FTSE 100 off 54.8 points at 4702. The markets were said to be waiting for publication on Wednesday of minutes from the last MPC meeting to get a better picture of the Bank's thinking on interest rates.

The ONS also said that under the harmonised European measure Britain had inflation of just 0.8% last month - the lowest of any country in the European Union. The average interest rate in Europe is 2.2%.