A sharp slowdown in inflation at the factory gate last month has set the scene for a further reduction in interest rates, analysts said yesterday.
But a survey to be published today suggests that the recovery in retail sales continued in January, adding to the evidence that weakness in manufacturing is being offset by stronger consumer spending.
Economists expect the Bank of England to warn about signs of buoyancy in the economy, such as broad money growth and the retail recovery, in its quarterly Inflation Report tomorrow. However, a quarter-point cut in base rates is expected when the Chancellor and Governor of the Bank of England meet early next month.
Andrew Cates, at UBS, said: "The sluggish state of the manufacturing economy and weaker inflation figures are powerful weapons to a Chancellor who needs to lower base rates to aid his party's political fortunes."
Prices paid by manufacturers for their inputs fell 0.3 per cent in January. Their year-on-year inflation rate dropped from 5.9 per cent in December to 4 per cent, lowest since mid-1994.
The unexpectedly big decline reflected lower prices for industrial commodities, although the prices of agricultural commodities and oil rose.
The pound's recent gains also contributed to the slowdown in costs.
Prices charged at the factory gate rose 0.4 per cent last month. Their year-on-year rate of advance fell to 3.8 per cent from 4.4 per cent in December. This was the lowest since last March, although exaggerated by comparison with an unusually big price rise in January 1995.
"Core" output prices - excluding food, beverages, tobacco and petroleum - were flat, even though January is a month which normally brings increases in manufacturers' list prices.
Sean Shepley, UK economist at CSFB investment bank, said: ''Manufacturers are facing excess stocks and weaker orders. There is pressure for them not to raise prices."
The inflation improvement was spread across a wide range of industries. The highest price increases were in pulp and paper and machinery.
Adam Cole, an economist at brokers James Capel, said: "These figures are clearly pointing to a further decline in retail price inflation."
He predicted that the Bank of England's inflation forecast published tomorrow would be lower than last time.
Other economists were not quite as optimistic. Marian Bell at the Royal Bank of Scotland said: 'Manufacturing accounts for only a quarter of the economy. The pick-up in earnings growth could affect retail prices."
Further evidence of retail buoyancy is provided by the British Retail Consortium. According to its survey of high street spending, released today, the value of sales rose 4.1 per cent in the year to January. This was a little lower than December's increase.
Last month's increase occurred despite the impact of two National Lottery double rollovers and unusually bad weather. Andrew Higginson, chairman of the BRC's economic affairs committee, said: "Retailers were relieved to see the gains achieved before Christmas continue through into January, in contrast to last year."
The strongest sectors were food and drink, electrical and household goods.
Overseas visitors helped ensure high sales levels in London stores.