- Bank governor forced to write to new Chancellor
- Rising cost of food places most pressure on prices
- inflation figures make gloomy reading for savers
- Inflation likely to fall back to its 2% target within a year
The economic nightmare confronting the new coalition government got worse today after inflation rose to a 17-month high in April – placing further pressure on interest rates.
The rise triggers an open letter from Bank of England governor Mervyn King to new Chancellor George Osborne to explain why inflation remains above the Bank’s 2 per cent target.
Increased fuel prices, rises in alcohol and tobacco duty and the cost of women’s clothing all combined to push consumer price inflation to levels not seen since November 2008.
The higher than expected figures could increase nerves among policymakers and shift them towards rate hikes to prevent the cost of living rising out of control.
The figures showed annual food inflation reaching 2.6 per cent last month – the highest since last July – with broad-based price rises across meat, fruit and vegetables compared with falling costs a year ago.
The Consumer Prices Index (CPI) hit 3.7 per cent, the highest since November 2008 and well ahead of the 3.5 per cent expected by the City, the Office for National Statistics (ONS) said.
The headline Retail Prices Index (RPI) also jumped to 5.3 per cent – the highest since July 1991 – as mortgage interest payments edged higher last month, in contrast to a year earlier when lenders passed on rate cuts.
The ONS added that disruption from Iceland’s volcanic ash cloud last month had little upward effect on food prices.
The latest figures also make gloomy reading for savers already struggling to earn a real return on their cash.
The increase in the Consumer Prices Index means a basic rate taxpayer now needs to earn interest of 4.63 per cent on their savings to prevent the value of their money falling in real terms, while a higher rate taxpayer needs to earn 6.17 per cent.
The situation is worse for those paying the new 50 per cent tax rate, as they would need an account paying more than 7.41 per cent to see the value of their savings rise, once inflation is taken into account.
With the Bank of England base rate still at a record low of 0.5 per cent, there are no instant access accounts paying rates high enough to enable savers to beat inflation.
Alcohol and cigarette duty free hikes in March’s Budget added to inflationary pressure, while clothing and footwear prices also rose by more than a year ago.
Food, drink and clothing added a combined 0.3 percentage points to the CPI, the ONS said, offsetting falling furniture costs.
The official figures also showed average petrol prices hitting 120.2p a litre last month – the highest since records began in 1996 – but the impact on inflation was limited, despite misery for motorists due to similar rises a year earlier.
The same factors influencing CPI were also behind the RPI rise, although the figures showed a 0.6 per cent rise in mortgage interest payments compared to a 7.7 per cent fall in April last year in the wake of the Bank of England cutting interest rates to a record low 0.5 per cent.
In his open letter to the Chancellor, Mr King said inflation is likely to fall back to its 2 per cent target ‘within a year’ after the cost of living hit a 17-month high of 3.7 per cent in April.
The governor blamed high oil costs, a weaker pound and the rise in VAT to 17.5 per cent in January for the consumer prices index (CPI) being “somewhat higher than expected” over the past year.
CPI is now almost double the Bank’s 2 per cent target but Mr King said inflation was likely to fall back as these temporary factors fade.
But the ‘pace and extent’ of the fall is uncertain and the Bank will monitor developments closely, the governor added.
ING economist James Knightley said CPI inflation should move back below 2 per cent in the next couple of years.
‘There are risks, though, with the threat of further sterling weakness and the potential for higher VAT putting some upside risk to this view.
‘Nonetheless, given the weak growth, tight fiscal policy environment, we believe that interest rates will be on hold through the rest of this year with the prospect of only very modest interest rate rises next year.’
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