Economists warn inflation could hit 3%

Published on Tuesday 17 November 2009 20:52

INFLATION will continue to spiral upwards in the short term as rising oil costs, the weak pound and the reversal of the cut in VAT keep up the pressure on prices, economists warned yesterday.

It came after official figures showed the rate of annual consumer price inflation picked up to 1.5 per cent last month from a five-year low of 1.1 per cent in September.

The result – mainly due to statistical effects resulting from a sharp drop in fuel prices in October last year – was ahead of forecasts but remains shy of the Bank of England's 2 per cent target.

Central bank policymakers have already pencilled in a near-term rise in inflation and yesterday's data is unlikely to persuade them to tighten policy soon.

However, some analysts reckon a rebound in commodity prices, combined with a 25 per cent depreciation in the pound over the last two years, and the reversal of the government's cut in VAT could drive the Consumer Prices Index (CPI) to 3 per cent or above in the short term.

JP Morgan economist Malcolm Barr said: "The likelihood of a temporary rise in inflation is widely established, but we continue to think the magnitude of the move up has the potential to be troublesome for the Bank's monetary policy committee (MPC)," he warned.

Howard Archer, chief UK and European economist at IHS Global Insight, said October's inflation spike "looks set to be the start of a relatively short, sharp rising trend".

He predicted CPI was likely to reach 2.5 per cent and "could well go higher still in the early months of 2010".

That hike should prove temporary, Archer added.

Worries about the longer-term health of the economy prompted the MPC to pump an additional 25 billion into the economy this month, taking its quantitative easing programme to 200bn, and King said policymakers had an open mind on whether more may be needed.

Minutes from this month's MPC meeting, due to be published today, should provide clues at to whether QE is now drawing to a close.

George Buckley, chief UK economist at Deutsche Bank, said dissenting votes were more likely to have been in favour of a 50bn increase rather than none at all, but said November's voting pattern was difficult to predict.

"I wouldn't be surprised to see a 7-2 or a 6-3 outcome," he added. "The big question is whether Mervyn King was outvoted again."

Yesterday's inflation data showed the Retail Prices Index (RPI), which includes house prices, rose from minus 1.4 per cent to minus 0.8 per cent on the month – the biggest month-on-month rise in more than 19 years.