18 Jan 2011

Inflation rises to 3.7 per cent

The rising cost of fuel and food caused inflation to hit 3.7 per cent in December, up from 3.3 per cent in November. As Faisal Islam reports, this could lead to a rise in interest rates.

The Consumer Price Index tracks everyday costs like petrol, utility bills, food and air fares and is used by the Government to measure inflation. The rise in December to 3.7 per cent was the biggest month on month rise since 1996.The only sign of a fall in living costs came in the clothing sector, where the bad weather put pressure on retailers to offer competitive prices.

The rise was partly driven by domestic pressures, as a cold winter damaged vegetable crops, leading to a 1.6 per cent increase in the cost of food. Gas price rises added to the cost of household services, which rose by 1.4 per cent.

But global influences played a large part. Droughts and fires around the world, including in Russia, led to a shortage of bread and grains. Experts are also pointing to an impact from US monetary policy, which has been encouraging risky investment in commodities.

Fear of further revolutions across the Middle East could see worried Governments in the region offer food price cuts to stave off riots.

Inflation is expected to continue to rise next month, with a surge above 4 per cent by February.

Faisal Islam analysis:
"Whichever way you slice it, inflation is back. CPI, RPI, month-on- month at a record, and even core inflation too. It will take X-ray vision to attempt to "see through" this rise, and thus basically ignore it.

"The Consumer Price Index was well above expectations at 3.7% in December, and almost double the Bank of England’s target rate of 2%. Inflation on the CPI measure is almost certain to surge above 4% by February.

"Of course this will come as little surprise to anyone filling up a petrol tank, or at a grocery checkout or paying for their gas bill...

Read more on Faisal Islam's blog: Interest rates - where now for Government's Plan B?

Interest rate rise?

As Faisal Islam reports the Bank of England is now under pressure to raise interest rates from it’s all time low of 0.5 per cent.

In a recent survey in the Financial Times, half of city economists questioned whether the Bank was ignoring its inflation target.

“At the Bank they flatly deny any backsliding on the inflation target, but they will also recognise that the genie may be seeping out of small cracks in the bottle,” says Faisal Islam.

“As MPC member Andrew Sentance told me last month acting decisively now, will lessen the pain of even higher rate rises in years to come. A small rise now will merely be taking the foot slightly off the accelerator rather than slamming on the breaks.”

Howard Archer, chief European economist at IHS Global Insight, agrees that the Bank’s Monetary Policy Committee is likely to act soon: “There is clearly a growing likelihood that the Bank’s Monetary Policy Committee will act before mid-year. The MPC could well decide that a small near-term interest rate hike would support its credibility by sending out the message that it is serious about its inflation mandate, but would not have a major dampening impact on growth.”

But not all economists think the rise in inflation is a reason to worry.

David Kuo, Director at financial website The Motley Fool said: “It is time for the Bank of England to ask the Government to raise it’s target for inflation from 2 per cent to a more realistic target of 4 per cent. A higher target would immediately relieve unncessary pressures on the Monetary Policy Committee to raise interest rates at a time when domestic economic growth is expected to be slow.”

But whatever the decisions of the Bank of England, as Faislam Islam adds; “This creates a monster headache for the Government. For sceptical voters facing lighter pay packets, rising unemployment and rising prices, there is the prospect of higher borrowing costs too.”