A drop in retail prices in January has given the Chancellor, Kenneth Clarke, another green light for a reduction in the cost of borrowing next month.
The headline rate of inflation is now at its lowest for just over a year. Yesterday's figures followed an unexpectedly optimistic Bank of England inflation forecast on Wednesday.
The only possible barriers to a cut in base rates after the next monetary meeting on 7 March are next week's figures on retail sales and broad money growth in January, analysts said. But most think the Chancellor will trim rates by a quarter-point, for the third time in four months, to 6 per cent.
"Every economic indicator during the past two weeks points to a further cut. One or two bad figures can be dismissed," said Andrew Cates at UBS.
Interest rate hopes helped share prices climb to close to their previous record. The FT-SE 100 index closed nearly 35 points higher at 3779.8, only 1.5 points below its all-time peak. The pound ended the day unchanged against a range of other currencies, reversing earlier losses after the publication of the Scott Report.
Retail prices fell 0.3 per cent last month, taking the headline inflation rate down to 2.9 per cent from 3.2 per cent in December. Lower mortgage rates and smaller increases in excise duties this year than last accounted for the decline in inflation.
The Government's target measure of inflation, the retail price index excluding mortgage interest payments, slowed to 2.8 per cent from 3 per cent in December. Underlying inflation, which also excludes tax changes, was unchanged at 2.5 per cent.
"This suggests that underlying inflationary pressures have at best stabilised following the upwards surge over the past 14 months," said Kevin Darlington, an economist at the brokers Hoare Govett.
However, others were far more optimistic. Adam Cole at James Capel said: "The prospects for inflation through the course of this year and next are excellent."
Although there were small price rises in most categories last month, there were huge falls in the prices of clothing and household goods.
The need to clear stocks meant clothing and footwear prices fell 5.6 per cent in January - the biggest one-month drop since February 1921. They have fallen 0.7 per cent during the past 12 months, their lowest inflation rate since April 1959.
Household goods fell 3 per cent in price, their biggest one-month decline since records for the category began in 1956. However, their 12-month rate of inflation remained at 3.9 per cent. Retailers had bumped up the price of some goods - mainly furniture - in December in order to put them on special offer in the January sales.Reuse content