STAGFLATION is casting a shadow over Britain’s economic prospects despite a small drop in the inflation rate announced today.

Experts warned that the fall may only be temporary and is combined with flatlining economic growth.

Nevertheless, the surprise reduction in December’s inflation rate to 2.5 per cent, down 0.1 per cent after three months of rises, was a glimmer of hope for a government otherwise beset by bad news.

It raises the possibility that the Bank of England may start cutting interest rates, now at 4.75 per cent, which would help growth prospects by making borrowing cheaper.

"If it stays like this, we will be on route to slightly more interest rate cuts,” said Michael Saunders, a former member of the bank’s monetary policy committee.

The inflation drop was driven by lower price rises by hotels and restaurants and in air travel, according to the Office for National Statistics.

Leading independent financial advisers deVere Group were downbeat about the prospects, warning that underlying inflationary pressures were still extant and likely to lead to price rises in future months, which complicates the bank’s interest rate decisions.

DeVere Group chief executive Nigel Green warned: “Investors should not be lulled into complacency by this brief reprieve.

“The data may appear to suggest progress, but the underlying forces are merely taking a breath,” he said.

“Stagflation risks remain firmly on the table, with potentially severe consequences.”

He added: “The dual threat of persistently high inflation and stagnant growth still looms large.  

“We maintain that inflation is poised to reaccelerate in the coming months.”