Inflation down slightly but still above target

UK prices remained subdued as the underlying rate of inflation slipped 0.1% last month to 2.7%, official figures showed today.

The figures from the office for national statistics (ONS) were better than expected, although the underlying rate, which excludes mortgage interest payments, was slightly higher than the government target of 2.5%.

"It's a bit better than expected," said Adam Chester, an economist with Halifax bank. "The surprises were from petrol and food prices. The underlying message is yes, inflation is above target but it is not running away."

While underlying inflation edged down, headline inflation - which includes mortgage interest payments - rose to 2.9%, up from 2.6% in November. The rise pushed headline inflation to its highest level since November 2000, and was due to changes in mortgage interest payments, as last year's rate cut was not repeated. Large downward effects came from food, clothing and footwear.

Economists expect underlying inflation to stay above the government target of 2.5% throughout most of 2003. Overall, the underlying rate is likely to remain at 2.8%, according to HSBC economists.

Sir Edward George, the governor of the Bank of England, today said the overall economy was not in bad shape but expressed concern over "terrific imbalances".

In an interview with BBC Radio Scotland, Sir Edward said: "We have a terrific imbalance between the internationally exposed sectors on the one hand, which are suffering, and that includes manufacturing of course, and the domestically oriented sectors on the other."

Sir Edward defended the Bank of England's policy of low interest rates - at their lowest in almost 40 years - by saying that, had the Bank not encouraged consumer spending, the UK would have suffered from weak growth.

"If we didn't do anything to try and encourage consumer spending, we would have suffered very slow growth, even negative growth, through that period of slowdown," Sir Edward said.

His comments followed on from remarks he made in Glasgow last night, when he played down fears of a sharp fall in consumer spending and a crash in house prices, the two elements that have been propping up the UK economy.

Sir Edward, who steps down in June, told bankers that low borrowing costs and a strong labour market could help to avoid the fall in consumer spending feared by some City analysts.

"The possibility of a sharp rise in unemployment depends substantially on a sharp slowdown in consumer spending rather than the other way round," Sir Edward said. "Similarly, a sharp rise in interest rates is less likely if consumer spending is slowing down."

Sir Edward said he doubted that households would "suddenly run for cover" as the labour market remained "remarkably robust" and the prospect for inflation - and hence interest rates - remained relatively benign.

In the latest unemployment statistics, released earlier this month, the number of people out of work fell slightly. The ONS said the number fell by 5,000 to 1,515,000 in the three months to November last year, leaving the jobless rate unchanged at 5.2%.