British inflation unexpectedly fell to 1.8 percent, its lowest in more than a year in August, giving the Bank of England room to cut borrowing costs if the credit crisis deepens. Only last month markets were gambling that interest rates would need to rise again this year.
But a global credit squeeze has put paid to that hawkish outlook and woes at mortgage bank Northern Rock have raised hopes of an imminent rate cut. With inflation below the two percent target for a second straight month - and well under a decade high hit in March - the Bank of England may feel able to respond to calls for lower borrowing costs to protect against a feared financial crisis.
"The big driver of monetary policy will be the extent to which credit market dislocations are perceived to impact the real economy," said Philip Shaw, chief economist at Investec.
"Current inflation trends woudn't stand in the way of an interest rate cut if the Monetary Policy Committee felt it were necessary." The Office for National Statistics said consumer prices rose 1.8 percent on the year last month, below analysts' forecasts for a steady reading of 1.9 percent.
While the BoE has already predicted inflation will remain below or around the government's target for the next few months, pressure is mounting on policymakers to act decisively to ease fears in financial markets and among the wider public.
Customers of mortgage bank Northern Rock rushed to withdraw savings after the bank sought emergency help from the BoE on Friday and although the government has said it will guarantee all deposits at the embattled bank, nerves remain very frayed.
The BoE has been widely criticised for its softly-softly approach to the global credit crunch so far and on Tuesday injected more than 4 billion pounds into money markets in an emergency move to encourage banks to lend to each other. But that may not be enough. The US Federal Reserve is widely expected to cut interest rates on Tuesday in response to the crisis and many believe other major central banks will have to follow suit.
"With UK growth starting to lose steam, inflation risks running so benign and financial market strains remaining heightened there is a very strong argument for the Bank of England to pull the chocks away to lower rates," said David Brown, an economist at Bear Stearns.
Indeed, the broad message from the inflation numbers is that price pressures are largely under control for the time being. The biggest downward effect came from some mortgage lenders cutting their exit administration fees. Those cuts took 0.05 percentage points off the annual rate.
But there was also downward pressure from lower utility bills with housing, water, electricity, gas and other fuels inflation slipping to its lowest rate since March 2004. Clothing and footwear also exerted a downward influence as women's clothes prices rose less than a year ago. "While the further fall is welcome, there are a couple of reasons for caution," said Jonathan Loynes at Capital Economics.
"Unless oil prices start to fall very soon, energy inflation is likely to pick up sharply again over the next few months. Second, core inflation edged back up ... And finally, retail price inflation remains very high."