Inflation rate fell to 3 per cent in February

Chancellor and Bank of England receive a much needed boost pre-Budget
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Inflation showed a surprise fall to 3 per cent last month in what will be seen as a pre-Budget boost to Alistair Darling, the Chancellor.

Prices as measured by the Consumer Prices Index had risen at 3.5 per cent in January and the City had been forecasting a rise of 3.1 per cent in February.

It is the first time that price rises have slowed since September. Core inflation, which strips out volatile items such as energy and food prices, improved to 2.9 per cent in February, against 3.1 per cent in January.

Price rises as measured by the Retail Prices Index, which includes housing costs, however, remained unchanged at 3.7 per cent in February.

Howard Archer, chief economist at IHS Global Insight, described the figures as: "A nice downward surprise on the inflation front, which is good news for the Bank of England. Although consumer price inflation remained substantially above its 2.0 per cent target level in February, the fact that it moderated more than expected to 3.0 per cent from a 14-month high of 3.5 per cent in January should be pretty well received by the Bank of England and it may ease some of the apparent recent modestly increased concern within the Monetary Policy Committee over upside inflation risks."

The moderation in CPI inflation was primarily due to cuts in utility prices and the fact that food prices rose much less than a year ago.

Mr Archer said it was also likely that many retailers put prices up less this year than they had a year ago following the ending of the sales. "There was less sharp and extensive discounting in the sales in the first place. Furthermore, the inflation data suggest that not many more retailers passed on January's VAT hike in February," he said.

However, Mr Archer and many other economists still believe that despite the February improvement, the CPI could rise again over the next couple of months, not least as during the comparative period a year ago prices were falling at a time when the recession was at its deepest.

That effect should eventually unwind, however, with the consensus now that inflation should ease back by the second half of the year, making it likely that interest rates will remain low for some time to come to protect the economic recovery.

Mr Archer said he believed that the CPI could very well be under the 2 per cent target by the end of the year.

Royal Bank of Scotland is also predicting a modest increase in inflation in March. However it has revised its peak forecast down to 3.1 per cent in March/April from 3.7 per cent. The bank also expects to see the inflation rate undershooting the bank's 2 per cent target early in 2011. A rising oil price together with the pound's weakness, RBS warns, will exert upward pressure on the inflation rate.

A letter from the Bank of England's Governor is required if inflation is more than one percentage point above or below the Government's 2 per cent target.

While the recent weakness in the pound could still cause a rise in inflation, pressure in the form of wage rises has been muted, and Mr Archer also noted that shops would have limited room to raise prices because of this and the need for fiscal tightening over the next year to reduce Britain's yawning budget deficit.