Inflation edged down in February to the lowest level in over a year, official data showed on Tuesday, keeping hopes alive that easing inflation will allow hard-pressed consumers to increase spending this year and boost the economy.
However, the drop in the headline inflation rate to 3.4 percent from 3.6 percent in January was slightly smaller than economists had forecast, highlighting the risk that price pressures won't fade as quickly as the central bank and the government hope.
Sterling hit a session high versus the euro while gilts fell in the wake of the data, as the slow decline in inflation added to views that the Bank of England will be reluctant to sanction further asset purchases once the current programme ends in May.
Chancellor George Osborne is aiming to provide some relief for low and middle-income earners when he presents his annual budget on Wednesday despite his ongoing drive to erase Britain's huge budget deficit. Falling inflation is therefore seen as crucial for the fragile economic recovery to gather pace.
The Office for National Statistics said a drop in prices for housing, electricity, recreation and culture pushed overall inflation down, while a record rise in prices of alcoholic beverages contributed most to the increase in costs of living.
Economists had seen a drop in inflation to 3.3 percent, extending a decline from September's three-year peak of 5.2 percent.
The recent rise in oil prices didn't stop UK inflation from taking another step down in February, although progress has slowed a bit, said Capital Economics analyst Vicky Redwood.
Inflation may even pick up again briefly due to higher petrol prices and the risk of rising food costs. However, these factors should just slow the speed at which inflation falls, rather than preventing it from dropping at all, she said.
In a sign that underlying price pressures are fading as well, core inflation - which strips out volatile components such as food and energy - fell to 2.4 percent, the lowest since November 2009.
Britain's consumers have cut back spending sharply in recent years as price rises outpaced meagre wage growth and the government's tax increases and spending cuts are also hurting household budgets.
The Bank of England forecasts that consumption should pick up later this year as it predicts inflation to fall below its 2 percent target by the end of 2012.
Britain's recovery from the 2007-2009 financial crisis has been sluggish, but with the euro zone debt crisis easing and the United States on track for more solid growth, the mood is improving.
The government's budget watchdog -- the Office for Budget Responsibility (OBR) -- is seen lifting its growth prediction for this year a notch to 0.8 percent, and the government's budget is expected to show a smaller need for extra borrowing.
The lack of consumption has driven a number of well-known high street brands out of business, and many retailers are now turning to discounts to lure cash-strapped Britons.
The chief executive of Britain's second largest department store group Debenhams Debenhams, Michael Sharp, told Reuters that selling price inflation was about 5 percent in the six months to March 3 but that he expected it to abate in the coming six months, particularly towards July and August.
What typically happens is that prices take longer to come down than they do to go up, he said.
With the government's hands tied, the onus has been firmly on the Bank to support the economy.
The central bank left monetary policy unchanged this month, deciding that February's extra 50 billion pounds of quantitative easing was enough for now to support the economy. The minutes from the bank's March meeting will be published on Wednesday.
Most economists do not expect the central bank to add further stimulus once the current round of asset purchases ends in May as the economy seems to have avoided a renewed recession.
Some of the BoE's Monetary Policy Committee members also expressed concerns about whether inflation would fall as fast as forecast, once the effect of one-off factors such as the impact of the rise in sales tax at the start of last year had faded.