Lower inflation paves way for rate cut

Official figures today showed inflation falling from a two-year high in September, fuelling expectation that the Bank of England will lower the cost of borrowing later this year.

Figures from the office for national statistics (ONS) showed the underlying rate of inflation, which excludes mortgage interest payments, dropped by 0.3% to 2.3% in September.

The fall, in line with City expectations, was due mainly to lower motoring costs. Petrol prices fell last month, in contrast to sharp rises on the forecourt in September last year when the fuel crisis hit the UK and crude oil prices reached a 10-year-high.

The 2.3% annual rate is below the Bank of England's 2.5% target and leaves its monetary policy committee with room for further rate cuts. City analysts expect the Bank to cut rates by a quarter-point later this year and perhaps again early next year. The Bank has cut rates six times this year, most recently on October 4 when it trimmed rates by a quarter-point to 4.5% to boost confidence after last month's terrorist attacks on the US. The ONS said it was too early to gauge whether prices for foreign holidays had been affected by the terror attack on the US.

The cost of borrowing in the UK is now at its lowest level since 1964, but still higher than in the US or continental Europe. The Bank is under pressure to reduce the cost of borrowing further amid signs that the recession in the manufacturing sector is beginning to affect services.

"Some of the latest figures suggest the economy is weakening more, perhaps, than was expected," said Don Eggington, an analyst with Daiwa Research in London. "There's anecdotal evidence that points to weakening house prices. There's evidence that consumer confidence has weakened a lot in September ... so I would expect another cut in November."

The key is now likely to be retail sales figures due out on Thursday, which will indicate how the atrocities of September 11 affected consumers on the high street.