Small rise in cost of living keeps door ajar for cut in interest rates

Stiff price competition in Britain's retail sector softened the blow of rising energy prices on the cost of living last month and kept the door ajar for the Bank of England to cut interest rates, official data released yesterday revealed.

Although the annual rate of inflation nudged up from 2.4% to 2.5% - its highest level in more than nine years - pressure on clothing, footwear and household goods stores meant the increase was far smaller than the City had feared.

Dearer transport costs gave the biggest upward push to inflation for the third successive month, according to the government's preferred measure of inflation - the consumer prices index. With petrol prices affected by the devastation to US oil installations caused by hurricane Katrina, the Office for National Statistics said pump prices were up 4.6p in September alone and by 10p over the latest quarter.

Officials at the ONS said more expensive fuels and lubricants had accounted for 0.34 percentage points of the 0.5 point increase in CPI inflation from 2% to 2.5% since June. City analysts said there was little evidence that dearer motoring and domestic heating costs were feeding through into the rest of the economy - the main concern of Mervyn King, the governor of the Bank of England.

CPI inflation stands 0.5 points above its 2% target, but some in the City had been braced for inflation to hit 2.7% or even 2.8% last month - a level which would have all-but ruled out a cut in interest rates from the Bank next month.

Economists said the option of a pre-Christmas reduction in the cost of borrowing was still available to the monetary policy committee amid evidence that so-called core inflation - the cost of living with energy, food, alcohol and tobacco stripped out - has shown a much smaller increase over the past year and currently stands at 1.7%.

Marchel Alexandrovich, economist at Dresdner Kleinwort Wasserstein said: "CPI inflation rose to 2.5%, but on the day, the reading came in better than expected, and the outlook is now for a lower peak in the annual rate than previously thought. Core inflation remained relatively benign."