Inflation of 1.1 per cent puts rate rise in doubt

Inflation dipped unexpectedly last month, according to official figures yesterday that analysts said raised questions about the likelihood of an interest rate rise next month.

Inflation dipped unexpectedly last month, according to official figures yesterday that analysts said raised questions about the likelihood of an interest rate rise next month.

The surprise fall in the consumer price index, which the Bank of England targets, left Mervyn King, its Governor, on the verge of writing a letter to the Chancellor to explain why inflation is so far off target.

The CPI fell to 1.1 per cent in March from 1.3 per cent - its lowest annual rate since June last year and well below the Government's target of 2 per cent. It would take a further fall of just 0.2 percentage points to bring the CPI below the Bank's target band of 1 to 3 per cent, forcing an explanatory letter to Gordon Brown. The Bank in February forecast inflation would accelerate to 2 per cent in two years.

The headline rate, which is a better measure of the cost of living, rose 2.1 per cent from a year ago, or 0.3 per cent on the month, because of an acceleration in house prices, which are excluded from the CPI.

Although City economists had expected the CPI to rise 1.3 per cent, most stuck with their forecasts of a 25 basis point interest-rate rise next month. John Butler, at HSBC, said March's inflation "marks the trough ... [but] is unlikely to prove a constraint to further rate hikes". He added: "The MPC can no longer hide behind its inflation target", adding interest rate rises were justified "as insurance against the risk of medium-term disinflation".

Howard Archer, at Global Insight, said that while a rate hike in May "suddenly does not look such a certainty ... the Bank is likely to remain focused on the strength of house price inflation, and consumer borrowing and spending."

The Royal Institute of Chartered Surveyors revealed earlier this week that house price inflation had hit its fastest annual pace since October 2002, despite two interest rate rises in the past four months.

The Office for National Statistics said last month's dip in the CPI was driven by smaller petrol and diesel price rises compared with last year, when the US-led invasion of Iraq caused oil prices to rocket. Cheaper clothing, footwear, furniture and airfares to domestic and European destinations also helped to put a lid on inflation, the ONS added.

The figures again showed a divide between consumer goods inflation, which fell 0.6 per cent year on year last month, and all services inflation, which rose 3.1 per cent compared with the same month a year ago.

The financial markets today will focus on the minutes of the Monetary Policy Committee, which held the base rate at 4 per cent earlier this month.