AN unexpected decline in the rate of wage inflation took the City by surprise and added spice to speculation that the Chancellor of the Exchequer, Mr Kenneth Clarke, may opt for further reductions in interest rates despite Bank of England opposition.

Underlying growth in average earnings in May was 3.5 per cent, down from 3.75 per cent in April. The decline was all the more surprising because the majority of City economists had widely predicted an increase to 4 per cent.

Other data showed unemployment falling by 14,300 in June to 2,152,000, slightly more than City forecasts of a 10,000 reduction in jobless numbers but still reflecting only modest growth in economic activity.

An acceleration in wage inflation in response to tightening labour markets and reviving consumer confidence has been expected by most City forecasts on the basis of previous inflation cycles.

Bank of England opposition to last month's quarter point reduction in bank base rates to 5.75 per cent was also based on the assumption that inflationary pressures will soon emerge in the form of accelerating wage inflation.

Minutes of the meeting between Mr Clarke and Mr Eddie George, governor of the Bank of England, ahead of last month's rate cut show that Mr George argued against further reductions in interest rates because of the inflationary risks.

Monthly figures on average earnings growth can be erratic and need to be regarded with caution. Even so, reduction in the underlying rate of wage inflation goes a long way towards supporting Mr Clarke's decision to keep cutting interest rates.

Now, he may well use subdued inflationary pressures as reasonable grounds for further pre election interest rate cuts.