London Briefing/Fiona Walsh:The City of London gave a cheer last week as the Bank of England played Santa, delivering an early Christmas present in the form of a quarter-point cut in interest rates.

It was the first time the Bank's monetary policy committee (MPC) had agreed a cut in more than two years, and it took rates down to 5.5 per cent. The UK's homeowners breathed a collective sigh of relief - particularly as some economists predicted it would be followed by a series of reductions that will take rates down to 4 per cent by 2009. The celebrations proved short-lived, however.

On Monday, official data showed the price of goods leaving the UK's factories had soared last month at the highest rate in 16 years, driven by increases in petrol and food prices. Prospects of another early rate cut suddenly looked less certain, with the data highlighting the dangerous inflationary pressures building within the economy.

The nine members of the MPC often have the benefit of some advance economic statistics when they meet to set rates, but they would not not have seen output prices when they made their decision last week.

Had they seen the data, their decision might have been different. Although business leaders and the media were clamouring for a rate cut, the committee might instead have decided that the risk of rekindling inflation was too great, and resisted the pressure.

The primary role of the Bank of England is, after all, to keep consumer price inflation under control. Governor Mervyn King has already been forced to write one open letter to the chancellor (then Gordon Brown) to explain why inflation exceeded the government's targets in March. He will not want to write another one. But the warning signs are there. Inflation rose from 1.8 per cent to 2.1 per cent in October and November's figures, due next week, are anxiously awaited.

Meanwhile, economic alarm bells are going off all over the place - not least because of the continuing global credit squeeze and the very real prospect of recession engulfing the US next year. In the UK, there are signs of a slowdown in the all-important services sector, which these days accounts for some two-thirds of the economy.

Consumer debt is mounting and house prices are falling. The most recent figures from the Halifax, for example, showed that average house prices tumbled by 1.1 per cent in November, their third consecutive monthly fall.

At the same time, household budgets are becoming more strained. Figures issued yesterday from the Council of Mortgage Lenders showed that the percentage of income needed to service a mortgage has jumped to its highest level since 1991.

For first-time buyers, that means an average of 20.6 per cent of their income is needed to meet monthly interest payments.

Last week's rate cut will help, but not much. And there are an estimated one million homeowners whose fixed rate mortgages are due to expire next year. For them, the quarter-point cut will be a drop in the ocean as they struggle to meet their new repayment terms.

As the UK's economy moves into slowdown mode, but with costs continuing to rise, the MPC will have an increasingly tricky tightrope to walk in the months ahead.

Tesco gets ready to rumble with OFT

The UK's biggest retailer is squaring up to the Office of Fair Trading (OFT), headed by Irishman John Fingleton, for what threatens to be quite a fight.

At issue are accusations of price-fixing among the supermarkets and dairy processors, collusion which is said to have cost the country's consumers some £270 million.

It dates back to 2002 and 2003, when supermarkets raised the prices of milk, cheese and butter in what they maintain was a move to support British farmers after the devastating foot-and-mouth outbreak in 2001.

But price fixing is illegal - and last week Sainsburys and Asda, along with Dairy Crest, admitted their guilt. They agreed to pay fines totalling a maximum of £116 million, attracted no doubt by the offer of significant reductions in their fines if they co-operated fully and settled early.

Sainsbury's fine, for example, has been cut from £40 million to £26 million. However, Tesco has refused to play ball. Although it is co-operating with the competition authority, it is continuing to deny that it acted illegally. It insists it never pocketed a penny of the price rises.

The OFT, however, is equally determined to continue its pursuit of Tesco. It maintains that the price rises were never passed on to the consumer and nor did they go to the farmers.

The retailers and processors (which include Glanbia by dint of its former ownership of The Cheese Company) say that they acted openly and that the government was fully aware of what was going on. The letter of the law may have been broken, but not the spirit.

Tesco looks determined to see this one through, and has the resources to do so. It should be a fascinating battle.

Fiona Walsh writes for theGuardian newspaper in London