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Last Updated: Tuesday, 17 June, 2003, 09:46 GMT 10:46 UK
Rate cut hopes as UK inflation falls
Shopping basket
The underlying rate looks at retail prices
The UK's underlying rate of inflation fell by 0.1 of a percentage point to 2.9% last month - thanks to a big drop in petrol prices.

The headline rate of inflation, which includes mortgage interest payments, fell 0.1 of a percentage point to 3% in May, the Office for National Statistics said.

Inflation has now been above the government's 2.5% target for seven months in a row.

But the latest figures will reassure Treasury ministers it is under control - and give the Bank of England greater scope to cut interest rates.

This is very encouraging because the Bank of England had expected inflation to peak at above 3%
George Buckley, Deutsche Bank

Most analysts had expected the underlying rate of inflation to hold steady at 3%.

But a big drop in oil and petrol prices in the aftermath of the Iraq war exerted strong downward pressure.

Weaker house price rises than a year ago and smaller increases in the costs of foreign holidays than last May also helped drive inflation down.

Seasonal food prices - after bad weather affected European crops - exerted the strongest upward pressure.

Single currency

The figures also contained good news for Chancellor Gordon Brown.

The Harmonised Index of Consumer Prices (HICP), which Mr Brown said last week he wanted to adopt for the Bank of England's new inflation target, also fell.

HICP stood at 1.2% - the lowest since September - following a fall in the annual rate from 1.5% in April.

The HICP, which is the favoured measure in the euro zone, does not include housing costs and smoothes out fluctuations.

Mr Brown sees the adoption of HICP as a key part of the UK's preparations for entry to the single currency.

Corporate profits

Commenting on the HICP figures, Jonathan Loynes, of Capital Economics, said: "Further falls to 1% or less will increase concerns over deflation in the UK and put the Bank of England's Monetary Policy Committee under pressure to bring interest rates down."

Simon Rubinsohn, of Gerrard, said the fall meant interest rates "will have to be cut".

But he added: "There is the issue, however, of what this means for corporate profitability as there is clearly pricing pressure on the High Street and in the manufacturing sector which is struggling to raise prices."

George Buckley, of Deutsche Bank in London, said: "This is very encouraging because the Bank of England had expected inflation to peak at above 3% whereas it has not done so yet and in fact we expect it to fall back later this year.

"There are some lower numbers coming through in service sector inflation and in fact the only upward pressure this time were seasonal food prices which are notoriously volatile anyway."

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