Food inflation could derail VAT increase

FURTHER rises in food prices could cause annual inflation to accelerate to four per cent and endanger the government’s plans to hike VAT to 20 per cent in January, a leading City economist has warned.

Henderson’s chief economist Simon Ward said that recent rises in global food commodity prices may boost annual CPI food inflation to seven per cent by late 2010 from just 1.7 per cent in June.

A further increase to 10 per cent would imply annual headline inflation running at four per cent, double the Bank of England’s inflation target.

“Such an increase would hit consumer spending and recovery prospects by squeezing real income and money supply expansion. It would also risk destabilising inflationary expectations, particularly if the Monetary Policy Committee (MPC) were thought likely to respond to renewed economic weakness by restarting asset purchases,” he added.

“This could warrant postponing or cancelling the coming VAT hike,” Ward cautioned. He said the better-than-expected public sector borrowing numbers could justify cancelling the VAT rise, thereby cutting one percentage point off headline inflation.

However, a Treasury spokesman insisted the VAT hike is here to stay, arguing that controlling inflation is a matter for the Bank of England and its monetary policy tools.

Other economists have also expressed concern about the impact of rising food prices on the outlook for inflation. Barclays Capital recently raised its forecasts for CPI and RPI inflation based on food prices.