Inflation at new low

The Bank of England is under mounting pressure to cut interest rates after the government's key measure of inflation plunged to a 25-year low in January.

The drop to 1.8% from 2% in December was mainly driven by lower oil and petrol costs which have since rebounded, but it also reflected sluggish house prices and cheaper household goods and services.

Underlying inflation, excluding mortgage interest payments, has been below the government's 2.5% prices target for 22 months in a row, and is perilously close to the 1.5% level which triggers a public letter from the bank's governor, Sir Eddie George, to the chancellor, Gordon Brown.

Under the terms of the Bank of England Act 1998, Sir Eddie would have to explain why inflation has fallen a full percentage point below target and set out a strategy for getting it back on track.

Although the Bank cut rates last week by 0.25% to 5.75% to reflate the economy, most City economists believe that further cuts in the cost of bor rowing will be needed to boost the rate of price increases.

The Bank will set out its thinking on the outlook for inflation and interest rates when it publishes its quarterly inflation report today.

Since the US federal reserve began cutting interest rates aggressively at the beginning of January to boost collapsing business and consumer confidence, other central banks have been expected to follow suit. But economic activity in Europe has remained relatively robust, making both the Bank of England and the European central bank (ECB) wary of overstimulating demand. Even so, financial markets are pricing in a further quarter point cut in UK rates by the summer.

Jonathan Loynes, UK economist at the consultancy Capital Economics, believes that British rates will fall to 5% by the end of the year. He said: "It is becoming very clear from the inflation numbers that a US-style slowdown is not a necessary precondition for sharp falls in interest rates."

The office for national statistics said headline inflation, used as a benchmark by wage negotiators, fell to 2.7% from 2.9%, taking it to the lowest level since March last year.

With unemployment at a 25-year low, the more hawkish members of the Bank's nine-member monetary policy committee are thought to remain concerned at the possibility of a rise in wage inflation.