Lower transport costs in January helped
The pound slumped and government bonds rose as traders calculated that the news reduced the need for the Bank of England to continue increasing the cost of borrowing.
The Office for National Statistics said its index of consumer prices fell by 0.8 per cent between December and January, driven lower mainly by a decline in the cost of fuel and lubricants, cheaper European air travel and a fall in the price of food and drink.
This was the sharpest month-on-month fall in the index since January 2003 and left the annual inflation rate at 2.7 per cent, down from 3 per cent in December.
Although January was still the ninth consecutive month that the annual increase in the CPI index has been above the government's 2 per cent target, the pull-back may explain why the Bank - which had access to the data - decided to leave interest rates unchanged at its rate-setting meeting last week.
Howard Archer at Global Insight said: "This is a much more benign set of inflation data than expected, which will be of major relief to the Bank of England."
The City will now be eagerly awaiting the publication on Wednesday of the Bank's latest quarterly inflation report for further clues to its thoughts on the inflationary pressures within in the economy.
The minutes of the February monetary policy committee meeting will be released a week later and investors will be keen to see if the MPC's vote to stay its hand was as close as the 5 to 4 in favour of an increase to 5.25 per cent the month before.
Philip Shaw at Investec Securities said he thought that CPI inflation was likely to fall in the medium term.
"Last year's gas and electricity price hikes falling out of the calculation and utility prices beginning to fall in March will together lop 1.2% off CPI inflation over 2007."
But he added:" There is a chance that rates may not rise again, but we still suspect MPC nerves over pay will result in a further tightening."
The Retail Price Index, which includes interest payments on mortgages, and is therefore used as a benchmark for wage negotiations, saw its annual rate fall from 4.4 per cent in December to 4.2 per cent.
Source: Financial Times