Bank of England's woes just keep inflating

Inflation rose to 4% last month - the highest rate in more than two years, and twice the Bank of England's target. And it'll get worse before it gets better...

by Dave Waller
Last Updated: 24 Feb 2011

According to the Office for National Statistics, the Consumer Prices Index rose from the 3.7% it hit in December due to a couple of key factors: higher oil prices (petrol was up to £1.27 a litre in January), and the impact of the much-feared VAT increase, which rose from 17.5% to 20% at the start of the year. This helped drive up the prices of popular items like alcohol, furniture and restaurant meals, making life more expensive for all of us.

The result of all this is that inflation is now at its highest level since November 2008 - putting the Bank of England under increasing pressure to get off the fence and raise interest rates sooner rather than later. After all, the CPI measure has been one percentage point or more above target for 14 months now, and consistently trumped it for the best part of five years. Which has led some to question whether the Bank’s bean-counters really know what they’re doing.
Mervyn King will certainly claim that they do. It’s time once again for the Bank of England boss to swap his abacus for his calligraphy set and write to George Osborne, to explain why the inflation reality seems to consistently mock the Bank's target. King sent three similar letters last year, blaming one-off factors like the VAT rise, the depreciation of sterling and spikes in commodity prices. Maybe this time he’s moved on to aliens, the wrong kind of numbers, and the dog eating the economy…
The bad news for Merv is that inflation will probably get worse before it gets better. In February, for instance, the stats will have to factor in the normalisation of prices following the end of the January sales. Commodity prices, already high, will continue to rise as demand in China and the emerging markets drives further increases. This will put even more pressure on the Bank to take decisive action - and probably makes a rate hike in the near future, probably in May at the time of the next inflation report, increasingly likely.

But that doesn’t mean it’s necessarily the right time to raise the rates. Given the current state of the UK economy, with weak growth and take-home pay shrinking for the first time since the 1920s, a hike in the interest rate could be just the thing to put the kybosh on the prospects for economic growth. Either way we suspect this isn’t going to be the last time a letter from King drops on the mat at Number Eleven.

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