Inflation hits 2.5% target and is expected to go lower

Inflation hit its target for the first time in more than two years last month. In the latest in a flow of rosy economic statistics, figures yesterday showed the underlying rate of retail price inflation declined to 2.5 per cent in April from 2.7 per cent in March.

The news that Kenneth Clarke had delivered on his promise to hit the target by the end of the last parliament came a month too late for the Conservatives. Michael Saunders, UK economist at Salomon Brothers, said: "Ken Clarke could be forgiven a quiet moment of self-congratulation."

Figures earlier in the week showed the last government had bequeathed the new one lower inflation at the factory gate, a big fall in claimant unemployment last month and somewhat slower-than-expected earnings growth.

Inflation is likely to fall even lower during the next few months due to the impact of the strong pound on prices further back in the chain. But most economists agree with the Bank of England's diagnosis that the target measure will then start to climb again thanks to the strength of the economy.

Sharp falls in seasonal food prices, especially vegetables, helped take the target inflation measure, the retail price index less mortgage interest payments, down to the 2.5 per cent target for the first time since December 1994.

The headline level of retail prices increased by 0.6 per cent during April, while the annual rate fell to 2.4 per cent from 2.6 per cent in March.

Seasonal foods last month cost 13.5 per cent less than a year ago. Vegetables such as potatoes and cauliflowers have fallen sharply in price during the past two months.

Petrol prices fell slightly in April, and the rate of increase in goods prices slowed further. Even so, retailers have taken advantage of lower costs as a result of the strength of the pound to build up their margins.

"The core components of goods price inflation remain stubbornly high, despite collapsing producer and import price inflation," said Adam Cole at James Capel.

This echoed a remark in the Bank of England's Inflation Report earlier this week. The Bank noted that the pass-through from the higher exchange rate to retail prices had not been as big as past experience would have suggested.

The price of services increased at a much faster rate than high street goods prices in the year to April. At 3.3 per cent, it was almost twice as high as goods inflation of 1.7 per cent.

Paul Turnbull at Merrill Lynch said: "The inflation outlook this year is pretty good but looking further ahead there will be an upturn."

He added that it would be a modest increase, especially now the Bank of England can set interest rates independently.

Other analysts were still more optimistic about price prospects. Jonathan Loynes at HSBC Markets said: "The very steep fall in factory gate inflation over the last year is feeding through to the retail environment. The process has much further to go."

Separate figures yesterday showed an increase in the level of mortgage advances in April, rather than the usual seasonal decline. But Barclays Mortgages said the growth in lending was lower in than previous months.

Jim Chadwick, marketing director, said: "The dampening of growth in demand for mortgages should be seen as beneficial to the market, heralding a period of greater stability."