February 16, 2010 / 6:13 AM / 10 years ago

Inflation soars to 3.5 percent

LONDON (Reuters) - Inflation surged further above the Bank of England’s target in January, forcing Bank of England Governor Mervyn King to write a public letter where he said inflation should still get back on track later this year.

Governor of the Bank of England Mervyn King arrives to present the bank's quarterly inflation report news conference in London May 13, 2009. REUTERS/Chris Ratcliffe/Pool

Official data showed consumer price inflation rose to 3.5 percent in January from December’s 2.9 percent — in line with economists’ expectations, after a rise in value-added tax on January 1, as well as falls in oil and food prices a year ago coming out of the annual comparison.

But this increase to a 14-month high still took inflation more than a full percentage point above the Bank’s 2 percent target, obliging King to write a public letter to Chancellor Alistair Darling explaining the rapid price rises.

“Inflation is more likely than not to fall back to the target in the second half of this year, as the short-run factors wane and the influence of spare capacity builds,” King said.

Finance minister Alistair Darling — facing a national election by June — replied to King that the Treasury also expected inflation to fall below 2 percent by the end of 2010.

British inflation has risen rapidly from a five-year low of 1.1 percent set in September 2009, but most economists — like the Bank — are happy to view this as temporary and the mirror image of developments a year or more ago, when oil prices fell sharply, only to rise, and VAT was temporarily cut.

“Inflation fears are not about to evaporate altogether, but there is nothing here to panic the MPC into a premature tightening of policy conditions,” said Jonathan Loynes, economist at Capital Economics.

After the Bank’s quarterly Inflation Report last week, economists pushed back their expectations for the central bank’s first rate rise to the final three months of 2010, and markets were little changed after Tuesday’s news.

Core inflation, excluding food and energy, rose to only 3.1 percent from 2.8 percent, which Loynes said was perhaps a sign that “the vast amount of spare capacity in the economy is starting to weigh down on underlying price pressures.”

UK CPI HIGH COMPARED TO PEERS

Nonetheless, British inflation is still above that in the United States and euro zone — in part because of sterling’s 25 percent slide in the past year — and other economists are more concerned about the price outlook.

“There may be some who view this as a vindication of the Bank of England’s very dovish central projection,” said Ross Walker, economist at Royal Bank of Scotland.

“I think it’s nothing of the sort. It remains to be seen just how much inflation falls back from its peak and already there seem to be signs that ... we are going to overshoot their Q1 average that they published just a week ago.”

On the month, the consumer price index fell by the smallest

amount on record for a January, dropping 0.2 percent.

Besides the hike in VAT to 17.5 percent, the ONS said the other main upward effect came from transport costs, given a rise in petrol prices.

Bad weather pushed up food prices, and cauliflowers alone added 0.04 percentage points to the all-items CPI rate.

The retail price inflation gauge rose to 3.7 percent from 2.4 percent, versus forecasts for a reading of 3.8 percent.

RPI includes more housing costs than CPI, which matches the European Union Harmonised Index of Consumer Prices (HICP), and is used to index many social security payments and some wages.

Additional reporting by Christina Fincher and Fiona Shaikh, editing by Mike Peacock and Susan Fenton

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