Inflation set to rise

Sarah Davidson

November 16, 2010

King must write an open letter to the Chancellor if CPI rises more than 1% above the 2% inflation target and every quarter thereafter if it does not decrease. He wrote his fourth letter this year today.

It said: “The assessment is that the current elevated rate of inflation largely reflects a number of temporary influences, including the restoration of the standard rate of VAT to 17.5% in January, past rises in oil prices and the continued pass through of higher import prices following the depreciation of sterling since mid-2007.”

King said the Monetary Policy Committee, which this month voted to maintain the base rate at 0.5% and the stock of purchased assets financed by the issuance of central bank reserves (quantitative easing) at £200 billion, expects the prospective increase in the standard rate of VAT in January to 20% will keep inflation elevated throughout 2011.

“As a result, CPI inflation is expected to remain above target, and at a somewhat higher level than expected three months ago, for a period of a year or so,” added King. “Indeed, over the next few months the inflation rate might rise further.”

Annual inflation as recorded by the retail prices index (RPI) stood at 4.5%in October, down from 4.6% in September.

The Office for National Statistics said petrol and diesel, financial services and games, toys and hobbies were the most significant drivers to the increase in annual inflation between September and October.

The main downward pressure to inflation between September and October came from food.

Mortgage interest payments had only a small downward effect on the change in the RPI 12-month rate between September and October.

King added: “The MPC is ready to adjust policy – in either direction – in order to ensure that the risks to the outlook for inflation in the medium term remain evenly balanced around the 2% target.”

Paul Hunt, managing director of Phoebus Software, said: “Despite the expectation that inflation would remain broadly unchanged, I think these figures validate the MPC’s decision to keep the Bank Rate low.

“While interest-rate hawk Andrew Sentence might think the MPC has a ZANU PF-esque stance on inflation, Mervyn King should not be embarrassed about having to give his letter-writing kit another airing this month.

“The current level of inflation is good news for borrowers and first-time buyers who continue to face major disincentives from lenders preoccupied with working out how they’re going to pay back their government loans. It is to the Bank’s credit that house prices have risen relatively steadily for the last six months despite the lack of mortgage finance, but the MPC mustn’t get cold feet now.

“Rates obviously have to rise at some point, but with the public spending cuts now just over six weeks away, the fragility of growth in property prices should remind the MPC of the headwinds faced by the wider economy in the coming year.”

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