Record jump in inflation as VAT and fuel prices rise

CPI inflation jumped to 2.9% in December - the biggest monthly rise since records began (erm, in 1997).

Last Updated: 31 Aug 2010

The Consumer Prices Index measure of inflation soared to 2.9% in December, a whole 1% higher than in the previous month. That’s the biggest jump since the measure was introduced in 1997, confounding the City’s expectations of a 0.7% rise (although that would have been a record too). The rise in oil prices was the biggest reason for this year-on-year change, along with the change in VAT. Still, the size of the jump will probably have given Bank of England Governor Mervyn King a nasty shock: he’ll already be sharpening a pencil for his letter to the Chancellor this time next month...

It's a big hike (and the Retail Prices Index, which incorporates housing costs, saw an even more pronounced rise, from 0.3% to 2.4%). But to some extent, it was predictable. Back in 2008, oil prices were tumbling at record levels, producing a deflationary effect, while by the back end of last year they’d stabilised again – prices rose 0.2% last month, compared to a 6.2% fall the previous year. Equally, December 2008 was when Alistair Darling chopped VAT to 15%, which also pushed prices down (Capital Economics analysts reckon VAT accounted for about three-quarters of today’s rise). So although the extent of today’s increase was surprising, the statistical reasons behind it were not.

Since VAT returned to 17.5% this month, pushing prices back up again, the chances are that we’ll see inflation keep rising for a while yet – which probably means it will go beyond the 3% mark that requires the Governor to write a letter to the Chancellor explaining why this has happened. This is a daft enough idea at the best of times, and it’ll be even dafter next month given that it’s the Chancellor’s policy which is distorting the current figure ('Hi Al - err, VAT? Cheers, Merv').

Although today’s news pushed the pound up against the dollar, the chances of the Bank cranking up interest rates again (to offset spiralling prices) still seem fairly remote. The consensus seems to be that once this VAT effect is out of the way, the weakness of the economy will push inflation down again, without the Bank having to get involved. So perhaps Mervyn and co should just concentrate on worrying about how on earth they're going to unwind their quantitative easing programme...

In today's bulletin:

Cadbury surrenders - but Milks Kraft for £12bn
Record jump in inflation as VAT and fuel prices rise
Editor's blog: Cadbury goes the same way as our cars
Japan Airlines' crash-landing adds to BA's woes
The Parent Project: How pregnancy translates abroad

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