Drop in inflation leaves the way clear for another base rate cut

A fall in headline inflation last month to its lowest rate for two-and-a-half years left the path clear for the Chancellor to cut interest rates again.

Inflation is likely to head lower for the next year, City economists concluded, even though June also brought the strongest increase in retail sales growth since the beginning of 1990.

In the latest evidence of a consumer boomlet, the growth of high street sales volumes picked up after several flat months.

The strongest sectors were those most closely linked to the housing market, such as china, DIY, furniture and household goods, according to the Confederation of British Industry's distributive trades survey.

It was the ninth successive increase in retail sales volumes reported in the survey.

The balance of retailers reporting higher rather than lower sales volumes increased to 45 per cent in June, the highest balance since January 1990.

It was only the second time in the past six months that retailers' expectations have been fulfilled, and they now expect a similar increase this month.

Motor traders reported their biggest sales increase since February 1994, mainly due to private sales.

Despite the faster pace of activity on the high street, the headline rate of retail price inflation fell to 2.1 per cent, the lowest since December 1993. Lower housing costs, motoring costs and leisure goods contributed to the decline.

The RPI less mortgage interest payments, the Government's target measure, was unchanged at 2.8 per cent.

The failure of the target measure to budge, which disappointed some analysts, was mainly due to higher seasonal food prices. The colder than usual summer has delayed new crops, while the beef crisis and a burgeoning Japanese taste for pork have raised meat prices.

The prospect of declining inflation in the months up to the latest possible election date means many economists think Mr Clarke might opt for another quarter-point reduction in base rates.

"Obvious signs of rising demand notwithstanding, another slight fall in the headline rate might be seen as facilitating a cut in interest rates," said Geoffrey Dicks of NatWest Markets.

But Ian Beauchamp, chief economist at investment bank Hambros said: "There is no economic case for a cut in interest rates. The political case depends on the risk of having to reverse a cut before the election."