LONDON (Reuters) - Inflation in Britain held at a 2-1/2 year high in May as food prices rose, squeezing Britons’ finances and leaving rate-setters stuck firmly with the dilemma of how to tackle soaring prices while the economy is weak.
The Office for National Statistics said consumer prices rose 0.2 percent last month keeping the annual inflation rate at 4.5 percent, as expected. Rising food prices offset a drop in travel costs, as airfares dropped after the Easter holiday.
There was little market reaction as investors stuck to their bets that a weak economic outlook would keep UK interest rates at a record low 0.5 percent for the rest of the year.
Recent surveys have highlighted the fragility of the economy, which has essentially stagnated over the last two quarters even before the bulk of draconian government spending cuts began to bite.
Bank of England policymakers argue that the price rises remain temporary and related to supply side pressures over which it has little control, meaning raising rates would simply undermine firms’ and households’ ability to spend.
A study from the Institute for Fiscal Studies on Tuesday showed poorer families, who spend a bigger proportion of their income on food and fuel, have faced far higher inflation in recent years than richer ones.
“There is no strategy from the government to ease the pressure on working families,” the general secretary of union Unite, Len McCluskey, said in a statement “It’s time for this government to act in their interests and make the economy work for the many, not just for the few.”
Inflation has been above the Bank of England’s 2-percent target for 1-1/2 years and more pain looks set to come.
Utility firms have announced steep price increases for heating and energy and the Bank has warned inflation may hit 5 percent later this year.
Britain’s biggest retailers are beginning to feel the pinch as cash-strapped consumers tighten their belts.
Tesco missed forecasts with a second consecutive quarterly fall in underlying sales in its main British market as shoppers cut back on discretionary spending.
Finance Director Laurie McIlwee said the biggest challenges facing shoppers were higher prices for fuel and utility bills.
Despite above-target inflation, money markets are not fully pricing in a rise in UK rates until May 2012 and 10-year gilt yields remain close to this year’s lows.
Bank Governor Mervyn King has said repeatedly that the factors behind soaring prices are likely to be temporary, and warned last month that attempts to bring inflation down quickly would harm the economy.
He may also be cheered by a drop in core inflation which eased to 3.3 percent from April’s record high of 3.7 percent.
“We still think the Bank will look through the short-term spike,” said Hetal Mehta at Daiwa Capital Markets.
“The fact that core inflation fell will be reassuring to the Bank, and further diminishes the prospects of a rate increase this year,” she added.
Editing by Patrick Graham