The headline rate fell to 1.1 per cent in August, its lowest since July 1963. Economists had expected the figure to remain unchanged from July's 1.3 per cent. The underlying rate, which the Bank uses when setting interest rates, also surprised pundits with a fall, dipping to 2.1 per cent from 2.2 per cent against forecasts of a 2.3 per cent rise.
But hopes that pressure for further rate rises had eased were dashed after separate figures showed US consumer spending surged in August, sending stock markets tumbling on both sides of the Atlantic.
Business and industry seized on the inflation data, saying they justified their pleas for rates to stay on hold at 5 per cent last week. Ian Fletcher, chief economic adviser at the British Chambers of Commerce, said the Bank should have concentrated on the state of the wider economy rather than on house prices.
"Today's figures show that there remains very tough competition on the high street and that seems to be keeping the lid on retail price inflation," he said.
Adair Turner, director-general of the Confederation of British Industry, said the rate rise looked "premature" in the light of depressed prices in the retail and manufacturing sectors and low wage settlements.
"The subsequent rise in exchange rates was a blow to manufacturing confidence and threatens to worsen the imbalance in the economy, with housing and related sectors performing strongly but export sectors remaining under severe pressure," he said.
But economists said the Bank was right to have raised rates now to ensure it hit its target in two years' time, saying August's fall was almost entirely due to the erratic food component.
Seasonal food prices fell 10..2 per cent in August, a sharp fall from July's 2.5 per cent deflation. Overall food prices fell 1.4 per cent, the steepest fall since March 1997. The Office for National Statistics said good harvests had pushed down prices, especially for potatoes. Goods inflation fell to 0.5 per cent, the lowest since records began in 1987, while services inflation was unabated at 3.6 per cent.
John O'Sullivan, an economist at Greenwich NatWest, said: "It is hard to argue that these numbers have huge policy implications." Ciaran Barr, of Deutsche Bank, added: "The Bank will have looked through this report... when raising rates last week, and are more concerned with the projected inflation rate in two years' time."
The Bank declined to comment on the data but a Treasury spokesman said the figures had been affected by seasonal factors. "They [the Bank] have made it very clear they are expected to look at the situation at least two years ahead and they have to take many different factors into account."
Financial markets responded to hopes that pressure for rate rises had eased. The pound fell a third of a cent to $1.6067 while bond yields fell for the first day in three. The FTSE 100 raced ahead more than 50 points immediately after the figures were released but closed down 0.9 per cent after it emerged that US consumers went on a spending spree in August.
US retail sales rose 1.2 per cent in August, outstripping an expected rise of 0.8 per cent. The figures showed consumer spending, which accounts for two-thirds of the economy, remains at high levels. That is likely to raise concerns that the Fed will have to hike rates again to slow economic growth.
Outlook, page 19