Price hikes fuel demand for rates rise

SOARING oil and food prices will almost certainly have pushed inflation to its highest level for 26 months when new figures are published this week, fuelling further pressure on the Bank of England to raise interest rates.

• Mervyn King

The consensus among economists is that consumer price inflation for January will have risen to 4 per cent from a year ago - double the Bank of England's target rate and a steep rise from the 3.7 per cent increase seen in December.

Many commentators believe inflation has far from peaked with fears it will rise to 4.5 per cent or more in the coming months.

January's rise will also trigger yet another 'Dear Chancellor' letter from Bank of England Governor Mervyn King to explain why consumer price inflation is more than one percentage point above the target level and how he plans to address the issue.

Core consumer price inflation is expected to climb to 3 per cent in January from 2.9 per cent in December when the figures are revealed on Tuesday.

The inflation data will be followed by the Bank of England's latest quarterly inflation report on Wednesday which is predicted to confirm lower GDP growth projections for 2011 and higher consumer price inflation forecasts.

Howard Archer, of IHS Global Insight, said: "There is no denying that the Bank of England is in a hugely difficult position as it negotiates a tortuous path between high and rising consumer price inflation on one side and relatively fragile economic activity and serious growth headwinds on the other.

"It is clear that the Bank will revise up its near-term inflation forecasts, but if it also raises the longer-term forecasts appreciably, this will be a sign that higher interest rates are on the way in the near term."

Archer warned that consumer price inflation looks likely to move higher still in the near term due to higher oil and commodity prices. "It could well reach 4.5 per cent and seems likely to be above 4 per cent through the first half of the year," he said.

Archer said inflation will start heading down in the second half of the year and dip below 3 per cent before the end of 2011 as the impact from VAT developments, higher energy, commodity and food prices, and sterling's past sharp depreciation wanes.

Economist Chris Williamson of Markit said the BoE quarterly report will be scrutinised to see how any changes to its forecasts might affect the three-way split in the Monetary Policy Committee.

"Sterling has been boosted to a three-month high in recent weeks as analysts have pulled forward their expectations of a rate hike on average, with many expecting the first move in May as the Bank seeks to shore up its inflation-fighting credibility," Williamson said. "However, the pound may come under pressure if the report shows that growth projections have been revised down and inflation pressures will wane later this year."