Apr 18, 6:02 AM EDT

Drop in UK inflation raises doubts over rate hike

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Drop in UK inflation raises doubts over rate hike

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Drop in UK inflation raises doubts over rate hike

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LONDON (AP) -- Inflation in Britain unexpectedly fell in March, official figures showed Wednesday, suggesting that the Brexit vote's boost to prices is running its course and raising questions in financial markets as to whether the Bank of England will raise interest rates again this month.

The Office for National Statistics said consumer prices rose by 2.5 percent in the year to March, the weakest in 12 months and down from 2.7 percent the month before. The agency said the biggest drag on inflation came from prices for clothing and footwear rising by less than they did a year ago.

The decline, which confounded most economists' predictions for an unchanged rate, has made investors less confident that the central bank will raise interest rates on May 10. The recently resurgent pound fell sharply on the news and was trading 0.7 percent lower at $1.4188.

On balance, however, a quarter-point hike in the benchmark rate to 0.75 percent is still expected, not least because wage growth at 2.8 percent is outstripping price rises. That raises consumers' purchasing power and could shore up economic growth.

"This week's strong labor market figures will embolden those in the Bank of England with the view that interest rates need to be raised to prevent the economy from overheating," said Pablo Shah, an economist at the Centre for Economics and Business Research.

Though the British economy is one of the laggards among industrial nations, with growth easing since the Brexit vote, it is operating near its capacity, which could stoke inflation. Unemployment, for example, is at its lowest rate since 1975.

This comes at a time when the Brexit vote's immediate impact is waning: the pound slumped in the immediate aftermath of the June 2016 vote to leave the European Union, prompting a rise in the cost of imported goods, such as clothes, energy and food. That price impact is now falling out of the annual comparisons.

Though Brexit will continue to affect the British economy, some of the near-term concerns have been alleviated by the news last month that the British government and the EU have agreed on the outlines of a smooth transition period after Brexit day on March 29, 2019. Under the transition, which will come into force if the two sides agree on a wider divorce agreement, Britain will remain part of the tariff-free single market and customs union until the end of 2020.

Confirmation of the transition deal gives policymakers at the Bank of England some room to focus on bringing interest rates up to more normal levels, after slashing them a decade ago during the global financial crisis. And with inflation still above target, rate-setters, who last November backed the first rate hike since the crisis, may not get many better chances to raise borrowing rates again soon.

"The Bank would dearly love some more firepower to counter the next economic downturn, whenever that may be," said Ben Brettell, senior economist at stockbrokers Hargreaves Lansdown. "Higher rates now will mean scope for a loosening of policy should the economy take a turn for the worse."

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