Surprise fall in inflation cuts interest rate pressure

New data showing a rise in inflation of just 4 per cent last month came as a shock to economists, who expected that the cost of living – measured by the Consumer Price Index (CPI) – would increase again, as it has done for nine months. The index stood at 4.4 per cent in February.

The falling cost of food and drink was the main driver of the lower CPI, the Office for National Statistics' figures revealed.

The price paid for products including fruit, bread and cereals, slumped as supermarkets and grocery shops slashed costs amid falling consumer confidence in the wake of looming public sector job cuts and tax changes announced in the Budget.

Lower-than-expected inflation will weaken the prospect of an interest rate rise – which will come as welcome news for Scotland's home-owners, but a disappointment for those with healthy balances in their savings accounts, who were hoping rates would begin an upturn.

Members of the Bank of England's Monetary Policy Committee (MPC) have recently come under increasing pressure to raise interest rates – which have remained at 0.5 per cent for 25 months in an effort to kick-start the country's flagging economy.

• Liz Cameron: Boost for businesses but it may be only temporary

• Another letter on way from Bank Governor

• Exports hit record high

• Martin Flanagan: Inflation double what it should be, but fall eases pressure

However, retail sales dropped by the largest amount in 16 years last month, according to data published yesterday by the British Retail Consortium, as shoppers tightened their belts.

Fears over the health of the retail sector, combined with the lower-than-expected rise in the cost of living, are likely to deter the MPC from rushing to raise interest rates, which analysts had believed could be as early as next month.

"The silver lining for mortgage borrowers is that it defers even further an increase in the bank rate – there now looks like a very serious possibility that the bank rate could still be 0.5 per cent at the end of the year," said mortgage broker Ray Boulger, of John Charcoal.

"The weakness of consumer demand may itself place downward pressure on prices over the coming months, negating the need to tighten monetary policy," added Scott Corfe, economist at the Centre for Economics and Business Research.

Business Secretary Vince Cable said the drop was encouraging.

"I am encouraged. There is a problem and we are importing a lot of inflation," he said. "But the Bank of England has kept its nerve, and I think they deserve great credit for that. They are looking ahead, and they have kept interest rates low, which is what the economy needs."

Other measures of inflation also dropped last month. The headline rate of Retail Prices Index (RPI) inflation, which includes mortgage costs, was 5.3 per cent in March, down from 5.5 per cent in February.

However, the headline inflation figure – which measures the cost of living by analysing 650 goods and services collected by the Office of National Statistics – is still double the government's target of 2 per cent.

It is believed that the average wage growth in March was still well below headline inflation – at just 2.2 per cent.

This month's data was based on a new basket of goods, which for the first time included the cost of online dating websites and apps for smart phones.

According to the ONS figures, the cost of food dropped by 1.4 per cent between February and March this year, compared with a rise of 0.3 per cent between the same two months a year ago. Yet annual food price inflation still remains at 4.5 per cent – double the level in the United States and the eurozone.

"We must not become complacent," said Iain McMillan, director of CBI Scotland. "There are considerable price rises in the pipeline. The pound has still lost a lot of its value, prices of raw materials coming in from other parts of the world are still rising and petrol is also on the up.

"However, what we also have to remember is that George Osborne's Budget was not expansionist. The removal of spending power in the economy is going to act as a brake on inflation."

The Bank of England itself has previously warned that inflation could hit 5 per cent in the coming months, but economists were yesterday divided over whether the downward trend could be set to continue.

"It could be a blip, but it may not," added Mr McMillan.

"Once again, there is a major surprise on the inflation front – but for once it is a pleasant surprise," said Howard Archer, chief UK economist for IHS Global Insight. But he warned that early price discounting in March ahead of a late Easter could have limited the rise.

"It is far too early to say that we are coming out of the inflation woods, particularly given the current level of oil prices and the risk that they could go higher still," he added.

• Additional reporting by David Newbury.