'Milk wars' prompt surprise fall in rate of inflation

Inflation slowed unexpectedly to its lowest rate in more than a year in March, after a supermarket price war broke out in milk and dairy goods and the cost of air fares dropped. Yet household bills rose at their fastest annual pace in at least nine years, prompting caution among analysts.

The consumer price index rose by 1.8 per cent in the year to March compared with an annual rate of 2 per cent the month before, official figures showed yesterday. Between February and March, prices rose by 0.2 per cent.

Higher energy bills were offset by sharp declines in food prices and continued discounting on the high street, while the cost of air fares fell for the third month running. The average price of a pint of milk dropped by 2p after a massive price war broke out among Britain's major supermarkets, led by Asda which is fighting to regain market share. The price of cheese and eggs also came down alongside vegetables such as cauliflowers, cucumbers and lettuces due to plentiful supply.

The fall took inflation back below the Bank of England's inflation target of 2 per cent and came as a surprise to City economists, who had predicted the rate would either remain at 2 per cent or drop slightly to 1.9 per cent. The weak outturn triggered a jump in government bonds and drove FTSE 100 stocks to a more than five-year high as traders reckoned the figures reduced the likelihood that the Bank's Monetary Policy Committee would raise interest rates later this year.

John Butler, at HSBC, said: "Competitive pressures and weaker consumer demand seem to be keeping a lid on inflation. Overall, this number is a blow to the interest rate hawks."

MPC members have warned that inflation would rise above the target due to higher energy bills, with the cost of crude oil hitting fresh record highs in the past week. So far, inflation has failed to pick up, having been at or below the Bank's target for four months. Core inflation, which strips out volatile items such as energy, food, alcohol and tobacco, edged lower to 1.3 per cent from 1.4 per cent.

However, the cost of housing, water, electricity, gas and other fuels rose at its sharpest annual rate since the data series began in January 1997. Amit Kara, at UBS, said: "Going forward, we are going to see gas price hikes coming through and I think the Bank will continue to remain vigilant ahead of that."

Separately, figures from the Council of Mortgage Lenders showed gross mortgage lending hit £28.3bn last month, the highest March on record.