Council tax rise makes no impact on inflation

Inflation remained steady last month despite hefty increases in council tax, official figures showed yesterday, raising hopes the door may still be open for further interest rate cuts by the Bank of England.

The underlying measure of inflation, which strips out volatile mortgage interest costs, stood at 3% for the third month in a row, the office for national statistics reported, confounding predictions in the City of further rises. "This is a pleasant surprise," said Philip Shaw, an economist at Investec bank. "It leaves open the prospect of the Bank of England cutting interest rates again if activity remains weak."

Council tax rose by 12% in the year to April, the sharpest increase on record. But the impact on inflation was offset by the fall in oil prices following the end of the war on Iraq.

The underlying rate has been above the 2.5% target since February. Some analysts had predicted it could breach the 3.5% level that would require the Bank to write a letter of explanation to Gordon Brown.

But with growth in the housing market easing and sterling's slide not expected to add to price pressures, many believe inflation will start falling. "Inflation is not a problem and the targeted measure should ease back to 2.5% by early next year," said Mr Shaw.

The Bank of England predicted last week that the current spike in inflation would prove temporary, despite the sharp slide in the pound since the start of the year.

"Any upward pressure on goods inflation stemming from the lower pound will be largely offset by weaker domestic inflation," said Jonathan Loynes, the chief UK economist at Capital Economics.

Inflation in the services sector is continuing to ease, reaching an 18-month low of 4.2% last month. Slowing rent rises, cheaper holidays and lower car maintenance costs eased price pressures in the sector, which is less prone to competition.

"There is a strong chance inflation has peaked and we continue to believe a letter is more likely to come next spring, when it slips below 1.5%," said Mr Loynes.