Inflation fall calms fear over interest rates

The threat of a sudden rise in interest rates receded today after inflation fell back from a 17-month high.

Official figures showed that the Consumer Prices Index eased from 3.7% in April to 3.4% in May — slightly below the 3.5% expected in the City.

It suggests that inflation has peaked and is now heading back towards the 2% target, raising hopes among borrowers that the Bank of England will leave rates at 0.5% well into next year.

Inflation has been above target since December due to higher oil prices and the increase in VAT from 15% to 17.5%. It is expected to come down over the coming months as tax hikes and spending cuts dampen demand, although another rise in VAT in next week's Budget — possibly to 20% — could push inflation up again, at least temporarily.

Last month's decline was driven by a fall in food prices — particularly grapes — as well as slower rises in the cost of petrol, alcohol and tobacco.

The ONS said average petrol prices rose 0.3p to a record 120.5p in May, but the effect was deadened as motorists were hit by even steeper price rises a year earlier.

David Kern, chief economist at the British Chambers of Commerce, said: "Inflation peaked in April. It is important for the Bank to maintain low interest rates for a prolonged period.
"Any premature rise in interest rates would heighten the risk of triggering a new downturn."

Governor Mervyn King has said CPI should fall back to the Bank's target within a year as a weak recovery drags down prices, although further pressure could come as soon as next week if Chancellor George Osborne elects to raise VAT in the emergency Budget.