The year-long squeeze on wages is nearing an end, official figures for the three months to February suggest.
However, there are signs that Britain's inflation surge has peaked since the consumer price index hit 3.1% in November, the highest in more than five years.
Market watchers think the Bank of England is likely to raise interest rates to 0.75% next month to slow inflation, which is above its 2% target.
Inflation had risen to 3% following Britain's vote to leave the European Union as the pound slumped, pushing up the cost of imports.
"UK inflation fell unexpectedly to 2.5% in the year to March, its lowest level in a year, and down from 2.7% in February".
"It's this wage-price spiral which underlines the case for higher interest rates".
The British currency GBP=D3 slid 0.8 percent to $1.4173 in London trading, its lowest since last Thursday and a striking reversal from Tuesday climb to $1.4377, its strongest since the Brexit referendum.
In contrast, Pantheon Macroeconomics argues that inflation undershooting BoE forecasts 'suggests that investors have concluded too hastily that a May rate hike is a done deal.' It adds the decline in inflation reduces the BoE's need to raise rates a couple of times this year.
However, investors were spooked by the unexpected drop in the CPI figure and what it could mean for interest rates, sending the pound down almost 0.7% against the United States dollar to 1.418 and almost 0.6% against the euro to 1.148.
Inflation started to overtake wages in February a year ago, squeezing incomes.
"The labour market continues to be strong, and for the first time in nearly a year, earnings have grown slightly after inflation has been taken into account", said Matt Hughes at the ONS.
Analysts expect it to rise to 1.0 percent this year following two quarter-point hikes.
It later trimmed some of those losses to stand only 0.4 percent down at $1.4233. This was the weakest rate since March 2017, when prices gained 2.3 percent.
"Despite inflation continuing to fall for the second consecutive month, it still remains high, putting pressure on finances", said Giles Cross, chief executive at peer-to-peer business lender Folk2Folk.
The inactivity rate (the proportion of people aged from 16 to 64 years who were economically inactive) was 21.2%, lower than for a year earlier (21.6%) and the joint lowest since comparable records began in 1971.