Inflation falls short of Brown's target

The City was last night hedging its bets over the timing of the next rise in interest rates from the Bank of England after the government's new measure of inflation fell last month to its lowest level since the summer.

Price discounts forced on clothing and footwear shops by the sluggish start to Christmas cut the annual rise in the consumer prices index to 1.3% in November, well below the target of 2% set by Gordon Brown in last week's pre-budget report.

Analysts said the fall in the cost of living coupled with the presentational difficulty the Bank would have in raising borrowing costs at a time when inflation was undershooting could stay the hand of the monetary policy committee for the time being.

On the old measure used by the government for setting monetary policy - the retail prices index excluding mortgage interest payments - inflation was above its 2.5% target when the MPC pushed up interest rates from their 48-year-low of 3.5% in early November. The main difference between the two measures is that the government's new yardstick conforms to the internationally agreed definition of inflation by excluding all housing costs.

In November dealers had anticipated a further upward move in rates from the Bank in February next year, but with no real evidence yet of a pre-Christmas shopping spree, the markets were having second thoughts yesterday.

In the City's money markets, expectations that base rates would rise from their current 3.75% to 5% by the end of next year were pared back to 4.75%, while the odds on a February rise also lengthened.

"The widely held view among economists is that the Bank will next tighten policy in February, around the time the next [quarterly] inflation report is published", said Simon Rubinsohn of Gerrard. "We would not be surprised if the MPC chooses to wait a little longer before moving, particularly if the subdued inflation picture is sustained and the consumer continues to shun the high street."

A detailed breakdown of yesterday's data showed clothing and footwear prices down 4.3% on a year earlier, the biggest drop since June this year. Recreation and culture prices were 2.3% lower than a year ago, the biggest drop since the series began in 1997.

With cheaper alcoholic drink, tobacco and mobile phone calls also bearing down on the cost of living, the annual increase in the CPI fell slightly from the 1.4% recorded in October. The European Union average in that month - the last for which figures are available for all EU countries - was 1.8%, while for the 12 countries in the eurozone it was 2%.

The government's new inflation target, like the old, is symmetrical, meaning an undershoot has to be treated as seriously by the Bank as an overshoot. Since Mr Brown became chancellor in May 1997, CPI inflation has exceded its target only once - in May 1998. Several MPC members have stressed that the change in target will make no difference to monetary policy, as they believe a fall in house price inflation will narrow the gap between the RPI(X) and CPI measures of inflation.