It’s going to get worse before it gets better. Tuesday’s disappointing news that UK annual consumer price inflation rose to 4.4 per cent in July, up from 3.8 per cent in June and two-tenths of a percentage point higher than expected, underlines the policy dilemma facing the Bank of England. The largest upwards change since records began leaves CPI more than twice the 2 per cent targeted by the Bank’s beleaguered monetary policy committee.

The MPC is performing a bold hope trick, by taking no action on rates while insisting that it remains committed to its 2 per cent target. Even though a recent dip in the oil price and some commodity prices has raised hopes that inflation may be on the turn, that moment has not yet come. CPI may well keep rising until September, by which time it could hit a startling 5.5 per cent. Retail price inflation – the measure most closely followed by wage setters – also exceeded expectations, at 5 per cent.

The risk to the bank’s credibility is now so great that even if inflation starts falling later this year, as widely expected, the MPC may want to wait several extra months before daring to embark on a new rate-cutting cycle: it cannot afford to be caught out by delayed second- round effects. When that cycle does eventually start, however, it could be sharper than many expect. Short sterling futures suggest there is in effect no prospect of a rate cut before the end of the year. At best, it would seem the market is pricing in a half-cut, of just 13 basis points, by February, and perhaps 40bp in total by the middle of next year. This may be too pessimistic.

Lehman Brothers, for example, reckons CPI will be back to its present level by year-end and drop to 2.5 per cent by July. If CPI looks likely to be well out of letter-writing territory within 12 months, the MPC will want rapid action to stimulate growth. Wednesday’s inflation report is hardly likely to take a relaxed view. But if the MPC becomes more confident that food and fuel prices have peaked and that second-round effects remain subdued, monetary loosening could come fast.

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