LONDON (Reuters) - Annual inflation hit a 2-1/2 year high last month and core prices rose at a record pace, but central bank governor Mervyn King warned that reacting too quickly to rising prices could harm the economy.
Consumer prices rose a bigger-than-expected 4.5 percent year-on-year, the fastest pace of increase since October 2008, propelled by soaring travel costs around Easter and higher duty on alcohol and tobacco.
Britain is facing a toxic combination of rising prices and sluggish growth, with the economy effectively flatlining over the past six months and deep public spending cuts only now beginning to bite.
Inflation is running at more than double the central bank’s 2.0 percent target, forcing King to write to Chancellor George Osborne periodically to give the reasons.
“The MPC (monetary policy committee) judges that attempting to bring inflation to the target quickly risks generating undesirable volatility in output,” King wrote, saying the overshoot was largely due to a rise in VAT sales tax in January and higher energy and import prices.
In reply to King’s letter, Osborne said the government’s austerity plan gave the central bank the scope to leave interest rates lower for longer.
“I welcome the MPC’s continued commitment to respond flexibly to the economic outlook and to set policy to balance the upside and downside risks in order to meet the inflation target in the medium term,” he said.
Prices in April rose 1.0 percent month-on-month, a rise of a magnitude seen only once before, the Office for National Statistics said.
Particularly worrying was a jump in “core” inflation, which strips out volatile items such as food and fuel. This rose to 3.7 percent, the highest annual rate on record.
Sterling jumped and gilt futures extended losses after the figures fuelled speculation that the central bank would raise interest rates by the year-end, something markets are pricing in although not imminently.
Quarterly inflation forecasts published by the Bank last week showed inflation was likely to hit 5 percent before the end of the year, and not fall back to target until 2013. Given that, economists said Tuesday’s figures would not fundamentally shift its thinking.
“Even with this month’s surprise, which will obviously add to the nerves of the committee members, the on-hold rates members will want to wait for clearer and better economic data before they voted for a hike,” said Victoria Cadman at Investec.
The composition of the nine-man MPC will change next month when former Goldman Sachs economist Ben Broadbent replaces arch-hawk Andrew Sentance who consistently voted to raise rates.
Broadbent said on Tuesday that assumptions about the path of commodity prices had led the central bank to underestimate the rate of inflation but appeared to take a less rigid stance than Sentance, suggesting the 6-3 split on the MPC in favour of keeping rates on hold could tilt back.
Asked if he was a dove or a hawk, Broadbent told parliament’s Treasury Committee: “I’m sometimes one sometimes the other. I don’t think I’ve always been in the same direction.
“On the broad thrust of policy, I think I would have followed pretty much what the Bank has done.”
Editing by Mike Peacock