Last updated: August 16, 2011 10:39 pm

Stubborn inflation stymies Bank

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The annual inflation rate rose slightly in July to 4.4 per cent, exacerbating the problems facing the Bank of England as economic growth falters at home and abroad.

Prices have been fairly stable for the past three months, but economists expect annual inflation to accelerate to about 5 per cent in the autumn when utility bills rise.

Sir Mervyn King, governor of the Bank of England, was forced to write his seventh successive letter to George Osborne, chancellor, to explain why inflation was so much higher than the Bank’s 2 per cent target.

“Although the committee’s central view is that inflation is likely to fall back in 2012, very significant uncertainties and risks around the outlook for inflation remain,” Sir Mervyn wrote. The Bank hinted last week that it could keep interest rates on hold for at least 18 months because of weak economic growth.

In his letter, Sir Mervyn said the biggest threats to the UK came from the rest of the world, including the eurozone. However, he said there was “a limit to what monetary policy can do” about these dangers. Some economists interpreted this as a reluctance to use more quantitative easing to stimulate the economy in light of high inflation.

“Generally there’s not a lot of room for manoeuvre on policy at the moment,” said Simon Hayes, economist at Barclays Capital. “The government has made it clear it doesn’t want to loosen fiscal policy, and the bank really is hemmed in on monetary policy because of these high and rising inflation rates as well, so all you’re left doing is what we’re doing: crossing our fingers, sitting tight and hoping we see an improvement in the second half of the year.”

UK inflation graph

The Bank thinks the high inflation rate is caused by high commodity prices, the depreciation of the pound and the increase in VAT this year. It estimates that these factors added 3 to 5 percentage points to CPI inflation during the last quarter. In other words, underlying inflation is very low. There was some evidence for this view in the inflation numbers. The consumer price index rose 4.4 per cent in July compared with a year earlier, up from 4.2 per cent in June, said the Office for National Statistics. But this high annual rate reflects a sharp rise in prices between autumn last year and spring this year, driven by rising food and fuel costs. Since April, the CPI has barely changed.

Annual core inflation, which strips out volatile food and fuel prices, rose from 2.8 per cent in June to 3.1 per cent in July. Economists said this was in part explained by a bounce back in prices after a June dip when retailers launched their summer sales early.

Food price inflation moderated slightly: food and non-alcoholic drink prices rose 0.3 per cent between June-July compared with a 1 per cent increase between June and July last year.

“Inflation is [not] as weak as we might have thought before this number, [but] there is still a dynamic where it’s slowing compared to what we thought 3 months ago,” said David Page, Lloyds Bank economist.

Consumer prices have increased faster  than wages, reducing real incomes. There were signs  in  the data that government austerity measures were contributing to inflation: the price of housing and household services rose 0.4 per cent between June and July, for example, driven by rent increases for social housing.

The retail price index was unchanged in July at 5 per cent, which means regulated train fares will rise by about 8 per cent next year.

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