Price cuts by retailers fighting to keep hard-pressed consumers in the shops last month triggered the steepest year-on-year falls in goods prices for nearly two years, helping to cap inflation.

The first signs that the growing squeeze on consumers may help to quell price pressures by stoking retail competition saw headline consumer price inflation remain stable in March at an annual 2.5 per cent.

The figures reignited City speculation that the Bank of England could now deliver a back-to-back cut in interest rates next month, on the heels of last week’s quarter-point reduction to 5 per cent.

Revived talk of a fresh rate cut sent the pound tumbling to a record low against the euro, which hit an all-time high of 80.65p. Sterling’s trade-weighted index fell to an 11-year low of 91.6.

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Earlier, the official data, more benign than expected, showed that prices for “core” goods, other than food, drink, tobacco and fuel, fell sharply by 1.8 per cent from levels a year earlier, in a sign of the more intense struggle by retailers to encourage consumer spending.

The news came after the first drop in like-for-like high street sales for two years. Strong downward pressure on inflation last month came as prices for furniture and carpets rose less sharply, reflecting the housing downturn.

Prices for furniture and household goods were up by just 0.5 per cent year-on-year in March, drastically cutting inflation on these products from 1.7 per cent in February. There were also clear signs of growing price competition among retailers of clothing and footwear, with prices for these in March down 5.3 per cent from a year earlier.

The most telling evidence of the “consumer crunch” came in prices for recreational and leisure services such as cinemas, with prices down 1.5 per cent as consumers appeared to curb spending on treats.

Upward pressures on the cost of living included a steep increases in air fares, which shot up by more than 15 per cent from the same time last year.Petrol and oil prices jumped by 2.8 per cent in the month alone, lifting their annual inflation rate to 20.6 per cent, the highest rate since October 1990.

Yet hopes of a further rate cut were bolstered as retail price index (RPI) inflation fell back sharply, dropping to an annual rate of 3.8 per cent last month, down from 4.1 per cent in February to an eight-month low. The Bank will take some comfort from this as the RPI figures exert a powerful influence on wage deals.

However, economists cautioned that the Bank is likely to remain cautious as inflation is still set to be pushed sharply upward again by big increases in utility bills that are still feeding through, and Budget duty increases.

Michael Saunders, of Citigroup, predicted that CPI inflation could jump to a rate of 2.8 per cent next month as the impact of these costs, as well as dearer prescriptions, postage charges and TV licences was felt.

Mr Saunders joined analysts in renewed predictions that inflation is still likely in coming months to breach the 3 per cent level that requires Mervyn King, the Bank’s Governor, to write an explanatory letter to the Chancellor.

Economists also sounded warnings that the inflationary impact from a plunge of 5 per cent in the pound’s overall value since February has yet to be felt.

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