July 15, 2008 / 11:18 AM / 11 years ago

Inflation surges as economic gloom deepens

LONDON (Reuters) - Inflation shot up to nearly double the central bank’s 2 percent target in June, intensifying doubts about whether the Bank of England can cut interest rates to prevent a sharp economic slowdown.

A shopper looks at produce in Borough Market, in London, June 17, 2008. REUTERS/Andrew Winning

The news that consumer price inflation leapt more than expected to 3.8 percent in June from 3.3 percent in May accompanied more survey evidence that the housing market is in real trouble and consumers are cutting their spending as a result.

“The UK economy probably is slipping into recession or about to. Even so, it seems very unlikely the Monetary Policy Committee will cut rates near-term given the extent to which inflation is surging,” said Michael Saunders of Citigroup.

“The MPC would probably hike rates if the economy were not anyway heading into a sharp slowdown or recession. They may yet do so.”

Inflation is now running at the fastest pace the Bank of England has had to deal with since it became independent in 1997.

Finance Minister Alistair Darling urged people not to push for higher wages, saying it would only lead to a debilitating wage-price spiral.

“We cannot allow inflationary wage increases because that would mean that everyone, especially people on lower incomes, would suffer,” he said.

Speaking just before the data came out, Bank policymaker Andrew Sentance said the risk of an economic slowdown needed to be balanced against the risk that inflation becomes embedded because people come to expect sharp price rises.

“This creates bigger upside risks for medium term inflation, and increases the possibility that a more pronounced or prolonged slowdown in the real economy will eventually be needed to bring inflation back to target,” he said.

MORE HOUSE PRICE GLOOM

Like everywhere else around the world, food and fuel prices were the main reason for the inflation surge.

The European Central Bank has already raised interest rates this month to combat the threat of rising commodity prices but the Bank is also having to contend with the prospect of a housing market crash.

The Royal Institution of Chartered Surveyors’ monthly survey of house prices for June pointed to further falls in house prices in the months ahead, with sentiment in the property market near record lows.

Retailers are also suffering. The British Retail Consortium said May’s hot weather-inspired jump in spending did not last and that retail sales fell last month versus a year ago. Furniture sales fell at their fastest rate in more than 3 years.

Photographic retailer Jessops added to the gloom as it warned its full-year loss was widening because of deteriorating trading conditions.

“While the economy continues to show signs of unravelling fast, the Bank is most likely to keep rates on hold in the near term until some signs of ameliorating inflation pressures emerge later this year,” said Matthew Sharratt, economist at Bank of America.

The Bank’s Sentance noted there was no sign yet of pay settlements picking up because of higher inflation but RPI inflation, which forms the basis for most wage deals, jumped to 4.6 percent in June, the highest since March 2007.

The Bank will be watching Wednesday’s labour market data carefully for any signs that average earnings are on the rise.

Slideshow (3 Images)

The government has said it is committed to keeping a tight lid on pay despite the squeeze on consumer incomes.

“What we want to avoid is any suggestion of any return to the sort of wage price spirals that we would have seen in previous decades when faced by a global inflation shock,” Prime Minister Gordon Brown’s official spokesman said on Tuesday.

Writing by Sumeet Desai; Additional reporting by David Clarke; Editing by Malcolm Whittaker

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