Inflation unexpectedly dropped last month, official figures show today, weakening the prospect of an imminent interest rate hike by policymakers at the Bank of England.

The headline rate of Retail Prices Index inflation, which includes mortgage costs, was 5.3% in March, down from 5.5% in February, the Office for National Statistics (ONS) says.

Key Points

  • RPI down from 5.5% to 5.3%
  • CPI down from 4.4% to 4%
  • But prices still rising sharply

Despite the fall in inflation prices are still rising sharply. All that's happened is the rate of increase has slowed.

The Consumer Prices Index (CPI) rate of inflation was 4% in March, down from 4.4% in February, but still double the Government's 2% target. City analysts had expected the CPI rate to hold at 4.4%.

The drop in the cost of living was driven by falling food prices, the ONS says, which slipped 1.4%, the biggest month-on-month drop since between June and July 2007, as supermarkets rolled out heavy discounts to draw in cautious consumers.

The improved figures will be welcomed by the Bank's Monetary Policy Committee (MPC) which has been under pressure to raise interest rates from their historic lows of 0.5%.

Last week, the MPC held interest rates for the 25th month in a row as it faced a challenging mix of soaring inflation and sluggish economic growth.

Economic theory suggests that when inflation is high, interest rates will go up as a way of curbing spending by encouraging saving.

The UK economy went into a shock 0.5% decline in the final quarter of 2010 and recent surveys of the services and manufacturing sectors have offered a mixed picture of the recovery.

The majority of MPC members believe the inflation surge is down to temporary price shocks and are minded to wait and see how well the economy fared in the first three months of 2011 before tightening monetary policy.

Business Secretary Vince Cable says the unanticipated drop was encouraging and says the Bank of England has "kept its nerve" in the face of global inflationary pressures.

"I am encouraged. There is a problem and we are importing a lot of inflation."