Hopes of rate cut rise as inflation hits target again

UK INFLATION has hit the Government target for the second successive month, according to official figures. However, analysts said evidence of mounting service sector inflation means that the data has mixed implications for interest rates.

The headline rate of inflation in September edged down 0.1 percentage points to 3.2 per cent - the lowest since June last year. The underlying rate - the target rate - remained unchanged at 2.5 per cent.

Richard Iley, economist at ABN Amro, said the figures revealed a "tug- of-war" in the UK economy between the goods sector, where inflation is easing, and the services sector where price pressures continue to build. The gap between services and goods inflation is at its widest since December 1993.

Mr Iley said: "If there is a key message from these numbers, it is that in internationally-isolated areas there is inflation, and this will concern the Bank of England."

September services sector inflation came in at 3.5 per cent, its highest level in more than four years. The rise was partly due to the fact that last year's reduction in VAT on fuel - part of the services inflation component - dropped out of the annual rate. Inflation in the goods sector was just 1.3 per cent, a four-year low.

Simon Briscoe at Nikko Europe said: "Non-seasonal food inflation and shop services inflation both rose, and are items to watch going ahead. The market should resist the temptation to get too excited about lower rates until the Bank declares its views on inflation in next month's quarterly report."

Despite these concerns, UK bonds rose sharply on a mixture of lower interest- rate hopes and bargain hunting. In the United States, Treasuries - government bonds - were higher in early trade as rumours of imminent rate cuts swept the markets. In Europe, bonds closed higher on renewed speculation about lower rates in the euro zone.

Speaking last night in Frankfurt Wim Duisenberg, the president of the European Central Bank, gave few hints about the likely level of European rates. Mr Duisenberg said there were increasing signs of a global economic slowdown, but he repeated his view that a co-ordinated cut in interest rates was not appropriate.

The ECB president gave more clues to the monetary strategy the bank will pursue when it takes responsibility for setting European rates in January. The ECB will aim to keep the Harmonised Index of Consumer Prices (HICP) - a European measure of inflation - below 2 per cent. Targeting money supply will also play a central role, he said.

The latest Royal Institution of Chartered Surveyors (RICS) report gave further evidence of a slowing UK economy. RICS said growth in the construction sector slowed last quarter amid growing concerns about economic prospects.

Meanwhile Gordon Brown, the Chancellor, last night attempted to dispel fears that a sharper-than-expected slowdown in the UK economy could jeopardise the Government's spending plans.

Speaking at the annual dinner of the British Retail Consortium (BRC), the Chancellor - who welcomed yesterday's inflation data - said: "Even with more moderate growth next year, we remain on track to meet our strict fiscal rules over the economic cycle while maintaining our commitment to an additional pounds 40bn for health and education."