Service sector slowdown fuels surprise drop in inflation to 2%

Prices charged by services firms rose at their slowest level for two and a half years in October, contributing to a surprise drop in inflation, official figures showed yesterday.

Prices charged by services firms rose at their slowest level for two and a half years in October, contributing to a surprise drop in inflation, official figures showed yesterday.

The UK's headline rate of inflation slowed to 3.1 per cent from 3.3 per cent in September while the underlying rate - which the Bank of England uses to set interest rates - dipped to 2.0 per cent from 2.2 per cent.

Economists in the City had expected no change and the fall was seen as further evidence that interest rates may have peaked. "This is all grist to the mill of the 'rates have peaked' school," said Geoffrey Dicks, a UK economist at Royal Bank of Scotland.

The pound fell on the foreign exchanges after the data were published.

The key factor last month was a 2.5 per cent fall in petrol prices, reversing the increase in September.

But apart from this, the main effect was from a slowdown in service sector inflation, which dipped to 3.1 per cent from 3.4 per cent. It is more than a percentage point off its 4.2 per cent peak in January and is running at its slowest pace since March 1998.

The fall was driven by a sharp slowdown in prices of services linked to the housing market, such as estate agents' fees and mortgage costs.

In contrast, there were signs that deflation on the high street might be easing. The prices of goods, other than the volatile petrol, alcohol, tobacco and food categories, fell 2.6 per cent - down from a peak of minus 3.3 per cent in July.

Ciaran Barr of Deutsche Bank said: "It is the future movements in goods price deflation which hold most importance."

Recently, prominent retailers such as Next and French Connection have claimed the end of falling prices is in sight. "If correct, then the market may well be calling the peak in interest rates too early," said Mr Barr.

Analysts are awaiting the Bank's quarterly Inflation Report, published tomorrow, which is expected to show the Bank has cut its two-year inflation forecast.

David Clementi, a deputy governor at the Bank, yesterday said the petrol crisis was a key uncertainty in the outlook for inflation and rates. "[This is] a particular problem relating to the third quarter as we try to assess the impact of the petrol price crisis in September."

The British Chambers of Commerce said competition was still "keeping a lid" on high street prices. Ian Fletcher, its chief economist, said: "Industry will be looking for a cut in interest rates sooner rather than later.

Sudhir Junankar, a senior economist at the Confederation of British Industry, said the Bank should signal that the next move in rates would be down.

The CBI yesterday published a regional breakdown of its quarterly industrial trends survey showing a further widening in the North/South divide.