Underlying inflation rate up 0.2%

Britain's underlying rate of inflation rose to 2.1% in September from 1.9% the month before, data from the office for national statistics showed today.

September's figure slightly exceeded City forecasts and is the highest since it reached 2.3% in April. But the underlying rate - which excludes volatile mortgage payments - still came in well below the government's target of 2.5%.

Analysts predicted that the Bank of England will leave interest rates unchanged at 4% at its next meeting in early October.

"In terms of the Bank of England, it will be pleased overall to see goods prices in check, but worried by the rise in service sector inflation," said George Buckley of Deutsche Bank. "It's difficult to conclude anything else than that rates are on hold for the moment."

Although rates have been on hold for eleven months running, some experts have argued for a cut in rates to protect Britain from the threat of deflation. DeAnne Julius, a former member of the Bank's monetary policy committee, warned that the Bank has been too focused on inflation.

"We don't have to a lot further to sink before we get dangerously close to deflation," she said in a Channel 4 interview to be showed tonight.

The headline rate of inflation, which does include home loan payments, rose to 1.7% from 1.4%, its highest level for a year. The ONS said the biggest upward contribution to the 12-month headline rate came from housing costs.

"A rise in mortgage interest payments this year, due to rising house prices, contrasted with a fall last September when the reduction in the Bank of England interest rate in August 2001 was passed on to borrowers," ONS said.

The second largest upward effect came from clothing and footwear, particularly women's outerwear. A further large upward effect came from motoring costs as petrol and oil prices rose this year while they fell last September.

A small downward effect came from household goods and tobacco where prices rose at a slower pace than last year. The figures also showed the continuing divergence between the prices for goods - down 0.9% from a year earlier - and services - where inflation rose to a 9 1/2 year high of 4.8%.

The trend has been in place for some time, but the gap appears to be growing, an indication of Britain's two-speed economy, where companies have trouble raising prices in a deflationary environment for goods, while the cost of services keeps going up.