Inflation falls by 0.5%

Britain's underlying rate of inflation in May fell 0.5% to 1.8%, its lowest level since January 2001, official figures showed today.

It was the sharpest month on month fall since October 1993 and well below the 2% forecast from the City.

The much better than expected figures from the office for national statistics (ONS) could ease pressure on the Bank of England when its monetary policy committee (MPC) discusses interest rate policy next month.

Some economists had predicted a rise in rates next month because the Bank had become increasingly concerned at the surge in house prices. The Bank has held interest rates at 4%, their lowest level in 38 years, for seven months running.

"The figures are significantly better than expected and may call into question whether the MPC will raise interest rates at its July meeting," said Philip Shaw of Investec. "This really is a volatile economic environment and the outlook for monetary policy is unclear. Clearly there are no inflationary pressures in the near term."

The underlying rate, which excludes volatile mortgage interest payments, came in well below the Bank of England's government-set target of 2.5%. ONS reported that changes in food prices, especially seasonal food, accounted in large part for the drop in prices last month.

A fall in petrol prices in contrast to the sharp rise in May last year, also contributed to last month's tame inflation figures. Other factors included a decline in the price of leisure goods as well as books and newspapers - a reflection of the price war between the Mirror and the Sun.

The headline inflation - which includes mortgage interest payments - fell to 1.1%, from 1.5% in April, and again below economists' forecasts of 1.3%.

Inflation has been below target for much of the last three years, and last month the Bank forecasted that inflation would stay below target for much of the next two years, only rising slightly above it in early 2004.

Apart from today's inflation data, the City will look carefully at minutes from May's meeting of the Bank's monetary policy committee meeting, due on Wednesday. Retail sales data from the Confederation of British Industry industrial trends survey are due on Thursday.