The FTSE 100 powered ahead, closing up 181 points at 5648.2 after official figures revealed that inflation fell in July for the second consecutive month. Separate data suggested that income tax self-assessment helped boost the Government's budget surplus.
Industry leaders renewed their calls for a rate cut after the Office for National Statistics (ONS) said headline inflation rate fell to 3.5 per cent in July from 3.7 per cent in June.
There was also a fall in the underlying inflation rate targeted by the Bank of England - so-called RPIX - which was down by 0.2 per cent to 2.6 per cent, just above the Bank's 2.5 per cent target.
City economists said a rate cut was unlikely until at least the New Year. Most forecasters - including the Bank of England - expect the rate of inflation to start to pick up again in the fourth quarter.
Francesca Massone at Goldman Sachs commented: "Until the MPC [Bank of England's Monetary Policy Committee] sees sufficient signs that the economy is slowing down, interest rates are likely to remain on hold."
The public sector net cash requirement (PSNCR) - the new name for the public sector borrowing requirement (PSBR) - stood at -pounds 5.4bn in July, meaning that the Government's budget was back in the black for the first time since April.
July's budget surplus was pounds 1.6bn higher than in July 1997, and beat market expectations by about pounds 0.8bn. Income tax revenues were up pounds 1.7bn on the year, partly because of the new self-assessment regime, according to City economists. VAT receipts were also higher than expected.
The public sector net borrowing requirement - which excludes gains from privatisation and is the Government's preferred borrowing measure - was -pounds 4.9 billion in July 1998, compared to -pounds 1.7bn in July 1997.
Stephen Byers, the Treasury's chief secretary, called the latest batch of economic data "encouraging". The Confederation of British Industry (CBI) said there was mounting evidence of a slowdown in the domestic economy which would see inflation reach the 2.5 per cent target this year.
Ian Fletcher, principal economic adviser to the British Chambers of Commerce (BCC) said: "These figures support our view that the time has come for the Bank of England to ease pressure on industry by cutting interest rates at its September meeting."
The inflation figures showed marked falls in prices for clothing and footwear, reflecting deteriorating conditions in the High Street, the ONS said. There was a slight pick-up in inflation in services.
Jonathan Loynes at HSBC Securities said: "Until such domestically-generated inflation shows convincing signs of easing, the Bank of England will continue to worry about the outlook for inflation."
Sterling closed at DM2.9055, up about 0.5 pfennigs.
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