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Inflation's left Bank of England in a tight spot

I t's been an InterestIng couple of days for economIsts. Yesterday's InflatIon fIgures weren't exactly unexpected, but they do hIghlIght some worryIng trends.

Annual inflation hit a two-and-a-half year high at 4.5% in April and core prices rose at a record pace, backing up the Bank of England's previous estimate that inflation could hit 5% before the year's end.

The Bank is now in a tight spot. It needs to try and keep inflation at its target rate of 2% and traditionally does this by raising interest rates.

The problem at the moment is that the UK economy is only showing the most minute signs of growth and a rise in the cost of borrowing could tip it back into recession.

In the past the Bank could afford to brush aside much of the inflationary number by attributing it to rising energy prices and it's true that higher oil prices were partly to blame for last month's hike, but in this instance that argument doesn't stand up.

Core inflation, which strips out food and fuel, rose to 3.7%, the highest annual rate on record and one which has probably sent a shiver down the spines of the Monetary Policy Committee.

One man probably champing at the bit will be Andrew Sentance, an MPC member who has been consistently calling for a rate hike over the last few months. He'll be replaced by Ben Broadbent, the former Goldman Sachs economist who is seen by many as adopting a slightly less hawkish approach.

But for how long the Bank can hold its nerve remains to be seen.

Like a naughty schoolboy, governor Mervyn King is forced to write a letter of explanation to the chancellor if inflation climbs above the 2% target.

In his reply George Osborne said the Government's austerity plan gave the Bank the scope to leave interest rates lower for longer. Let's hope he's right.


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