Inflation falls to lowest rate in six years

Britain's inflation rate has fallen to a six-year low, with the governor of the Bank of England, Eddie George, acknowledging luck had played its part in the economy's price-busting performance.

However, figures from the US later today may signal the end of the downward trend in the cost of borrowing which has been a feature of the world's major economies since the onset of the Asia crisis in the summer of 1997.

Analysts are already pencilling in a rise in US interest rates at the end of this month if today's consumer price index, which rose 0.7% in April, shows inflationary pressures continuing to build.

In the UK, the Office for National Statistics said the all- items retail prices index rose by just 1.3% in the 12 months to May. Inflation has not been this low since June 1993 when it stood at 1.2%.

Underlying inflation, the measure which strips out mortgage interest rates, fell to 2.1% which brings it below the government's 2.5% target for the second month in a row.

Last week the Bank of England cut base rates to their lowest since 1977 while mortgage rates have fallen to a 30-year low.

The bank has now cut interest rates seven times in the last nine months from their peak of 7.5% to 5 %.

Mr George told members of a House of Lords select committee that undershooting the target did not mean that Threadneedle Street would take its eyes off the ball in the fight against inflation.

"It would be totally misleading to say that because inflation was less than 2.5% we can forget about that and focus on the problems of the economy," Mr George said.

He admitted that the bank had enjoyed "a degree of luck" in keeping price pressures under control.

The chancellor, Gordon Brown, told MPs on the treasury select committee that the monetary policy committee had done a good job since he gave it control over setting interest rates two years ago.

"The Bank of England's monetary policy committee has shown itself able to respond positively at the right time. The general record of the MPC is that they have got it right. Inflation expectations as well as inflation itself have come down."

The chancellor declined to be drawn on individual interest rate changes by the bank, arguing that it was not part of his role to second guess the members of the committee.

But he said that under MPC control rates had peaked at 7.5% compared to 15%and 16% in previous cycles.

He warned against precipitate changes to the system either by altering the inflation target or by changing from Britain's current method of measuring inflation to the European Central Bank's harmonised index of consumer prices.

Mr Brown said he understood the concerns of Britain's export sector about the strength of the pound but added: "Anyone thinking about dropping the inflation target and replacing it with an exchange rate target has failed to learn the lessons of the 1980s."

Some economists said that most of the improvement in the UK's inflation performance is a result of subdued price rises in the goods sector which accounts for about half of the all-items index. Goods inflation has hit an all-time low of just 0.9% in the 12 months to May.

But inflation in the service sector, which makes up one-third of the index, has remained stubbornly high at a yearly rate of 3.3%.