Belfast Telegraph

Bank chief to explain inflation hike to the Chancellor

By Sean O’Grady

A hike in VAT, higher petrol prices and bad weather helped push inflation to a 14-month high in January, the Office for National Statistics said yesterday. Prices rose by 3.5% on the year, up from 2.9% in the 12 months to December.

The Governor of the Bank of England, Mervyn King, has had to write a further open letter of explanation to the Chancellor explaining why the rate of inflation has strayed by more than 1% from its official target of 2%. It is the sixth such letter in three years. As recently as last September, annual price rises were down to 1.1%.

In his letter, the Governor blamed ‘short-run factors’ for the rise — the restoration of VAT to 17.5% on January 1, the 70% rise in oil prices that pushed petrol higher and the lingering effects of the depreciation of sterling over the past two years of about 25%.

Mr King added: “As was the case on previous occasions, the committee expects this to be a temporary deviation of inflation from the target, as was made clear in last week's Inflation Report.

“Although it is likely to remain high over the next few months, 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.”

Replying, the Chancellor agreed that the inflation outlook was “subject to some uncertainty” as the world emerges from the “deepest downturn in modern times”.

The Governor's cautious tone suggests that interest rates will stay low for a protracted period, but there is a slight possibility that they could be raised sooner than assumed, as imported inflation — from commodity prices and the weak pound — outweighs the weakness of demand and spending at home.

The ONS said that over half the increase of 0.6% in the annual rate of inflation was due to rapidly rising petrol prices — up 25.3% on the year, from 86.3p per litre this time last year to 110.9p per litre now.

Fuel prices have suffered a ‘double whammy’ — higher VAT rates being levied on much higher underlying prices. Indeed motoring costs more generally have soared, driven up in particular, by used car values, which have climbed by 18.8%, as companies and hire firms have delayed renewing their fleets and disposing of older vehicles. Motoring costs are up about a fifth on last year.

Duty that was increased on alcohol and tobacco when VAT was cut to 15% was not reduced on January 1, also pushing inflation higher.

The unseasonal weather over the winter has also taken its toll as crops were damaged by the exceptionally cold weather. The cauliflower was at the epicentre of this economic shock — up 59.7% between December and January alone as the harvest in Britain and France was badly hit by frosts. Carrots, for similar reasons, jumped by 10.2% in a few weeks.

The Retail Prices Index, which also reflects the cost of housing, rose to 3.7% in January, from 2.4% in December even as the effect of last year's radical cuts in mortgage bills and the stabilisation of house prices start to feed through to the indices.

However underlying inflation — removing volatile items such as food and fuel — is also edging up, at 3.1% annually, up on 2.8% the previous month, suggesting underlying inflationary pressures, mainly from the weak pound.

Householders will also be deprived this year of the reductions in mortgage bills which were delivered throughout the latter part of 2008 and 2009 when the Bank of England cut interest rates to a record low of 0.5%.

By the end of this year, though, the trend should be in the other direction, as mortgage rates return to more normal levels. The cut in VAT to 15% implemented in December 2008 and the fall in petrol prices and energy bills are also well on their way to being reversed this year. These factors will contribute to one of the sharpest squeezes on living standards seen since the Second World War

Belfast Telegraph