Interest rate cut in UK remains some way off

Inflation dropped back towards the British government's target rate last month, but strong price rises for services suggest that a cut in interest rates remains some way off.

Underlying inflation, which excludes mortgage interest payments, fell from 2.8 to 2.6 per cent in July, barely above the target rate of 2.5 per cent.

The fall was in line with City expectations and the prediction of the Bank of England's quarterly inflation report last week. It reverses the blip seen during the spring, when tax increases pushed underlying inflation to 3.2 per cent.

The Bank expects underlying inflation to rise steadily to almost 3 per cent over the coming year before dropping back to the target as the economic slowdown restrains wage and price increases.

Inflation has been subdued by the strong pound, which has reduced import prices. But inflation in the sheltered domestic service sector remains relatively strong.

"Much greater weakness in domestically generated inflation is needed before the threat of higher base rates vanishes totally and rate cuts come on the agenda," said Michael Saunders at investment bank Salomon Smith Barney.

The retail prices index fell by 0.2 per cent last month to 163, compared with no change in the July figure last year. This pulled the headline inflation rate down from 3.7 to 3.5 per cent.

The main reason for the fall was that last year's increase in petrol duty fell out of the annual comparison. Clothing and footwear prices also dropped by 6 per cent during the month - a record for the time of year.

Stephen Byers, chief secretary to the Treasury, said the figures were a sign "that at a time of instability in the international economy, our economy is on track for economic stability which will see inflation at its target level and sustainable growth".

Separate figures showed the government raised £5.4 billion sterling more in tax revenue than it spent last month, a £1.6 billion increase on July last year. The Treasury said this was in line with expectations. Obviously, good news for the Chancellor, Mr Gordon Brown.