Combined with a fall in factory gate inflation to a fresh 24-year low of 3.2 per cent, this fuelled speculation that the Chancellor might be poised to announce a cut in interest rates. This helped to push the FT-SE index of 100 leading shares up 27.5 points to 2,584.7.
The key market interest rate that tracks City base rate expectations fell by 5 32 of a percentage point to 85 8 per cent, almost fully discounting a half-point cut from the current base rate of 9 per cent.
The pound see-sawed. After heading towards DM2.54, it closed 0.84 pfennigs higher on the day at DM2.5217. Against a basket of other currencies, it closed at 83.4 per cent of its 1985 value, up 0.6 points on the day.
A forecast by Trade Indemnity, the credit insurance group, that business failures would be 7 per cent lower between July and September than in the previous three months, did little to cheer the markets. 'The figures should not be taken as evidence that the end of recession is here', Barbara Bennett, of Trade Indemnity, said.
It remains uncertain what impact the lower pound will have on recovery but the City was relieved that its immediate inflationary effect was unexpectedly mild.
Fuel and raw material prices rose by 0.2 per cent last month, adjusting for normal seasonal changes. This was the biggest increase since February, but only a third the size City economists had forecast. The annual rate at which fuel and raw material prices are falling slowed from 1.1 to 0.4 per cent.
A large increase had been expected because the 10 per cent fall in the pound since Black Wednesday increases the sterling price of imported goods, although only half the effect would have fed through in last month's figures. Some 10 per cent of industry's fuels and raw materials are imported from the US or - like oil - have to be paid for in dollars. A further 47 per cent are imported from elsewhere.
The impact of the lower pound was offset in part by a fall in commodity prices in the month of around 8 per cent. 'But they could bounce back with a vengeance,' Simon Briscoe, economist at Midland Montagu, said.
Factory gate inflation - which measures the rise in prices charged by manufacturers for goods sent to wholesalers and retailers - was also better than expected. The 3.2 per cent rise in the year to September was the lowest since February 1968, and down from 3.4 per cent in the previous month. Between August and September prices were unchanged.
Excluding food, drink and tobacco prices - which are affected by Budget changes in excise duties - output prices rose by 2.6 per cent in the year to September, the lowest figure since May.
A rise in raw material costs normally takes about six months to feed through fully to retail prices, but economists believe the effect may be subdued as recession-hit firms find it difficult to raise prices. The effect is also expected to be offset by slower growth in unit labour costs.