Rates confusion as inflation falls

THE City today scaled back its expectations of a May increase in interest rates after a surprise fall in inflation to its lowest for 18 months.

Inflation on the consumer price index measure fell to 1.1% in March from 1.3% in February - the lowest since September 2002 and well below the Government's 2% target.

National Statistics said the main downward effect came from transport costs thanks largely to cheaper air fares. Smaller petrol and diesel price rises than a year ago also dragged down inflation.

The pound dived half a cent to $1.7902 as dealers judged that the news made a rise in the cost of borrowing at the Bank of England's next rate-setting meeting less likely. A quarter-point move to 4.25% on 6 May had been regarded as a racing certainty. Gilts and short sterling futures rallied.

'This number has put the cat among the pigeons,' said John Butler at HSBC. 'However, while it makes the transparency of raising rates against a background of very low inflation difficult, it is unlikely to prove a constraint to further rate hikes.'

Adam Chester at Halifax, said: 'It will make predicting next month's decision a bit more difficult. But I don't think the monetary policy committee will be taking too much notice of this. What matters is where inflation is going.'

The report also highlighted the differing fortunes of the manufacturing and services sector. Consumer goods prices fell by 0.6% year-on-year in March while services inflation ran at 3.1%.