Inflation fell by more than expected in January, according to official figures published yesterday, but analysts said it was too soon to say whether interest rates had peaked.
Consumer price inflation - the Bank of England's target measure - dropped to an annual 2.7 per cent from December's record high of 3 per cent, the Office for National Statistics said. This was lower than consensus expectations of 2.9 per cent.
The pound weakened on the news. Investors reduced their expectations of interest rates in the short-sterling market by around 0.08 percentage points for the rest of 2007 but they still expect another rate rise this spring.
The 0.8 per cent fall in the CPI index between December and January was the sharpest month-on-month drop since January 2003. The annual rate was driven down by a fall in transport inflation, mainly because of lower fuel costs. Cheaper European air travel and lower food price inflation as well as lower telephone charges also contributed to the decline.
The Retail Price Index, which includes interest payments on mortgages and is used as a benchmark for wage negotiations, fell to an annual 4.2 per cent last month from December's 4.4 per cent.
January was the ninth consecutive month that the annual increase in the CPI index has been above the Bank's 2 per cent target. But it was the first fall since September, and that is likely to have contributed to the Monetary Policy Committee's decision to leave its main interest rate unchanged at 5.25 per cent last week after January's shock quarter-point rise.
Mervyn King, the governor of the Bank of England, said recently that inflation could fall "possibly quite sharply" in the second half of the year and many analysts expect inflation to drop back to the 2 per cent target by mid-2007 as last year's energy price rises drop out of the annual comparisons.
But it is the medium-term outlook for inflation, which the Bank will set out in its quarterly Inflation Report today, that will determine the likelihood of another interest rate rise.
Michael Saunders of Citigroup said: "Just as last year's rise in headline inflation exaggerated the medium-term upside inflation problems facing the
These risks include public expectations of inflation creeping up, strong demand on the back of a healthy economy, higher wage settlements and companies seeking to rebuild profit margins through higher prices.
Jonathan Loynes at Capital Economics, the consultancy, said: "January's fall in consumer price inflation should put an end to the danger that the MPC will have to write an explanatory letter to the chancellor in the foreseeable future.
"Nonetheless," he pointed out, "with RPI inflation still above 4 per cent, the threat of a pick-up in wages growth remains and the committee is concerned over the strength of asset prices and money growth.
"As such," he concluded, "we still expect interest rates to rise once more during the next several months."
Source: Financial Times