UK inflation drops unexpectedly

Britain's inflation rate dropped unexpectedly to 1.8% in March due to lower food prices and transport costs, official figures showed today.

The consumer prices index (CPI) for last month, down from the Bank of England's 2% target in February, should go some way in assuaging Bank concerns about the inflationary impact of higher energy prices.

Oil prices hit a new high this week, surpassing the record levels reached last August when Hurricane Katrina disrupted production in the US.

Gas and electricity bills went up in March, but these were offset by lower food prices, particularly milk and fresh vegetables. Small downward effects on prices also come from lower airfares and a fall in the price of toys, photographic and sports goods.

"It appears that strong competitive pressures on the high street and through the supply chain are continuing to contain any second round inflationary effects of high oil and energy prices," said Howard Archer of Global Insight.

Although inflation last month was at its weakest level for over a year, the Bank of England remains concerned about the possibility that rising energy prices will feed through to the rest of the economy.

The Bank has left interest rates unchanged at 4.5% since last August. Bank minutes from its April meeting released yesterday showed that the majority of the Bank's monetary policy committee (MPC) are on the lookout for any knock-on effects of higher oil prices and any impact from further increases in utility bills.

The MPC is also in no hurry to lower borrowing costs as it expects inflation to stay on target at 2% with strong house prices and a rising stock market underpinning consumer spending.

"The current strength of housing market activity and prices will reinforce the Bank of England's caution over any trimming of interest rates in the near term," Mr Archer said.

In further evidence of the strength of the housing market, the Council of Mortgage Lenders (CML) reported today that gross mortgage lending in March had reached £28.3bn - an increase of 26% on the previous month.

This is the highest March lending figure on record and is 34% higher than the £21.2bn lent a year ago.

"Lending usually starts to pick up in March from the lull in house buying activity during the winter months. But lending has been unseasonably strong throughout the winter, producing five consecutive monthly record lending figures," the CML said.

"The record lending in March reflects the high level of loan approvals in the autumn and winter as house prices stabilised and consumer confidence returned to the market," the CML's director general, Michael Coogan, said.

" House-buying activity was particularly strong around London reflecting high city bonuses, and this is probably a factor behind the strength of lending."

Inflation in eurozone, meanwhile, fell 0.1 point to 2.2%in the month to March. The rate in March 2005 was 2.1%.