LONDON (Reuters) - Inflation jumped to twice the Bank of England’s target in January, prompting Bank Governor Mervyn King to acknowledge that interest rates might rise more rapidly than economists had expected.
Consumer price inflation surged to a two-year high of 4.0 percent from 3.7 percent in December, providing an awkward backdrop for the central bank’s updated quarterly growth and inflation forecasts on Wednesday.
Sterling hit a four-week high against the euro after the data and interest rate futures fell as investors bet on a series of rate rises over the coming year, starting in May.
In an obligatory letter to the government to explain why inflation remained so high, Bank Governor King highlighted differences of views on the monetary policy committee, raising speculation the hawkish minority was gaining ground.
“While Mervyn King would undoubtedly prefer to avoid increasing rates for now, he conveyed the impression that he has moved onto the back foot,” said Philip Shaw, an economist at Investec.
Rather than stress the one-off and temporary nature of upward price pressures, King admitted inflation was as likely to be above target as below it in two to three years’ time assuming interest rates rose as markets expected.
Analysts interpreted these comments as effectively endorsing market expectations of a May rate rise. Most economists until now have stuck with forecasts that rates would not rise until later in the year.
“We now expect the next move from the Bank of England to be a 25 basis point rate hike in May,” said Nomura economist Philip Rush who had previously expected an August move.
The central bank has held interest rates at a record low 0.5 percent since March 2009 and is reluctant to tighten policy at a time when a sustained economic recovery looks far from assured.
However, inflation has been at least a percentage point above the target for more than a year and investors’ patience is starting to wear thin.
“The issue for the Monetary Policy Committee is that inflation has overshot its target for much of the last five years and many are doubting its commitment to the inflation target,” said Amit Kara, UK economist at UBS.
Tuesday’s figures showed the biggest upward impact on inflation came from fuel prices and indirect taxation, following a rise in value-added tax from 17.5 percent to 20 percent at the start of the year.
Shadow Chancellor Ed Balls noted the government was not only suffering higher inflation than its main trading partners but also slower growth, and blamed the government’s austerity drive for putting the Bank in such a dilemma.
“It’s the worst of all worlds and I think the Bank is in a very difficult position,” Balls said. “The government is not supporting growth in the economy and at the same time they are pushing inflation up.”
Month-on-month consumer prices rose 0.1 percent, the first time since records began in 1997 that prices have risen between December and January — a period of post-Christmas discounting.
Retail price inflation, which includes more housing costs and is the benchmark for many wage deals, surged to 5.1 percent, its highest since last May.
King reiterated that the bulk of the upward pressure was coming from external forces such as commodity prices and the impact of a weak pound, and he acknowledged the risk that rising inflation could become embedded, leading to a wage-price spiral.
Two of the Bank’s nine-member Monetary Policy Committee voted for an immediate quarter-point rate rise in January and King’s comments about “real differences of view” on the committee suggested to some that February’s decision to leave rates on hold was even closer.
Alan Clarke, UK economist at BNP Paribas, speculated that minutes to the February meeting, due out next week, could show a 6-3 or even a 5-4 split.
Editing by Ruth Pitchford and Susan Fenton