A fall in the annual rate of inflation due to slowing house prices and cheaper foreign holidays took the City by surprise yesterday.

The headline rate dropped by 0.2 per cent to 2.6 per cent in October, its lowest since November last year.

Underlying inflation, which strips out mortgage interest payments and is the Government's target measure, fell 0.1 per cent to 2.7 per cent from 2.8 per cent in September - the lowest since January.

The Office for National Statistics (ONS) attributed the falls to lower house price growth than a year ago and the falling cost of foreign holidays.

HSBC economist John Butler said the figures were surprising and attributed them particularly to a sharp drop in inflation in services such as university fees and estate agency fees.

He said they may prompt the Bank of England's monetary policy committee to hold interest rates at their current level of 3.75 per cent when it next meets.

He said: "The fact that the drop in inflation reflects an apparent easing in underlying inflationary pressure, rather than simply a slowdown in house prices, should reduce at the margin the apparent urgency to hike interest rates."

Stockbroker Gerrard echoed HSBC, saying the figures were better than the market had expected.

But the group's chief economist, Simon Rubinsohn, said he was not ruling out another quarter-point rise in interest rates next month.

The slower house price growth led to much lower growth this year in figures reflecting the amount that homeowners need to spend to maintain their properties, the ONS said.

Prices of holidays in most European destinations also fell compared with 12 months ago.

University tuition fees and estate agent fees both rose less rapidly than a year ago and there were reductions in some telephone call charges compared with price increases this time last year.

Inflation for seasonal food items also fell, in particular as fresh vegetable prices fell back from high levels in September.

The ONS said the largest upward contribution in the all-items RPI annual rate for October came from a large upward effect from the purchase of cars and other vehicles, as second-hand car prices fell by less than last year.

The Harmonised Index of Consumer Prices, which is due to be adopted by the Bank of England for its new inflation target next month, remained unchanged at 1.4 per cent in October.

Wednesday November 19, 2003