Hopes of rate cut rise as inflation falls to 2.5%

THE UK inflation rate has hit itstarget for the first time since January, fanning market speculation about early cuts in interest rates.

The underlying inflation rate targeted by the Bank of England fell from 2.6 per cent in July to 2.5 per cent in August, while the headline rate was down from 3.5 per cent to 3.3 per cent.

The better-than-expected inflation data - combined with Monday's calls for a co-ordinated international response to the global financial crisis from President Bill Clinton and G7 finance ministers - raised market hopes of a reduction in UK interest rates. Sterling fell by more than 3 pfennigs to close at DM 2.8235.

However, senior government sources played down prospects of co-ordinated moves in interest rates, saying that rate cuts may be appropriate for countries in recession but inappropriate for the UK.

City experts warned that inflation was likely to rise again towards the year-end, meaning the Bank's room for manoeuvre on rates could be limited.

Gordon Brown, the Chancellor, briefing reporters before his departure for top-level finance meetings in Japan, also stopped short of calling for co-ordinated action on rates.

The Chancellor, who will today outline proposals for stabilising world economies, said: "I think the vigilance that has been shown shows we are keeping these matters constantly under review, and of course the finance ministers did say last night the balance of risks had shifted."

In today's speech, the Chancellor will welcome the commitment of Japan to financial sector reform and will use the British experience as an example of the tough measures needed to stabilise world economies. Mr Brown said the return of inflation to target showed the government's "tough action" was working.

Eddie George, Bank of England Governor, speaking at the TUC conference in Blackpool, made no explicit reference to interest rate cuts, although he admitted that "recent international developments have reduced the likelihood that we will need to tighten policy further".

The Governor said the UK was more likely to experience a "necessary slowdown" than "a more serious recession," and stressed that abandoning the inflation target would damage long-term economic prospects.