Bank signals pause in rising interest rates

The governor of the Bank of England, Mervyn King, last night fuelled City speculation that further interest rate increases are on hold after he responded to a surprise fall in inflation by saying the economy was in a "softer patch".

Speaking at the Eden Project in Cornwall, Mr King said the impact of the slowdown on inflation would be offset by the recent weakness of the pound but dropped a strong hint that there would be a pause before the Bank acted again.

"Looking ahead, the monetary policy committee will have to balance the impact on inflation of this evidence of weaker activity against the fall in sterling and other signs of cost pressures. The implications for interest rates will depend on developments in the economy, which the MPC will monitor carefully."

The governor made his remarks hours after the monthly figures for the cost of living in the UK showed the annual inflation rate on the government's preferred measure - the consumer prices index - falling from 1.3% to 1.1% last month.

Competitive pressures in the high street pulled down inflation to its lowest level since the spring and confounded market expectations that higher oil prices would see the annual rate tick up to 1.4%.

The Bank's task is to keep inflation at 2%, with a deviation of more than one percentage point from the target requiring the governor to write a letter to Gordon Brown explaining his conduct of monetary policy. Analysts said that had it not been for the sharp increase in global oil prices, Mr King would already have had to put pen to paper.

The Office for National Statistics said cheaper air and sea travel, cut-price offers on food from supermarkets and a reduction in the cost of telephone charges were the main reasons for the one-month fall in the CPI. Over the past 12 months, however, bargain offers for clothing and footwear and leisure goods have been the sectors of the economy where price falls have been largest.

Yesterday's data showed the price of goods last month was 0.4% lower than a year earlier, while inflation in the service sector stood at 3.2%. Britain had the third lowest inflation in the European Union, with only Denmark and Finland having smaller annual rises.

Other measures of inflation also fell in September. The all-items retail prices index showed a 3.1% annual increase, down from 3.2% the previous month, while the RPI excluding mortgage interest payments fell from 2.2% to 1.9%.

The September inflation figures are used as the basis for the annual uprating of state benefits. Income-related benefits such as jobseekers' allowance, housing benefit and income support will rise by 1% next year, while the basic state pension, incapacity benefit and disability benefit will increase by 3.1%. Mr King said what he has previously described as the "nice" decade - non-inflationary consistent expansion - was coming to an end and would be replaced by the "not so bad" decade.

"The combination of low and stable inflation and continuously falling unemployment must come to an end at some point, and may already have done so. Starting, as we do now, with little if any spare capacity, it is unlikely we can expect unemployment to fall indefinitely.

"From time to time shocks will hit our economy, as we have seen with oil prices and world trade, and there will be fluctuations in growth and unemployment, as well as inflation."