Weak sterling helps push up inflation rate

INFLATION is forecast to have surged in December, fuelling concerns that the Bank of England’s ultra-loose monetary policy is allowing inflationary pressures to build up.

Economists on average expect the annual rate of inflation in December – published on Tuesday – to hit 2.5 per cent, with further rises in the pipeline.

December marks the first month in which the 2008 VAT cut will drop out of the 12-month comparison and the figure will not include the recent hike. It is not just the VAT change that is putting upward pressure on UK prices. Citigroup’s Michael Saunders sees the weak pound and the lagged effect of the sharp rise in import prices as also having an impact.

He reiterates the point that the Bank is in danger of eroding its inflation-targeting credibility. Bank of England governor Mervyn King has said the Monetary Policy Committee (MPC) would look through the first quarter rise in inflation.

Investec’s David Page says that the data “provides a rare, undistorted glimpse of inflation”.
It is therefore instructive, Page adds, that this rate stands significantly above the Bank of England’s two per cent target, despite the collapse in economic activity. The VAT hike will only push inflation higher in January.

Henderson’s chief economist Simon Ward has said that the British Retail Consortium’s (BRC) strong December reading bodes ill for the consumer prices index (CPI) report. He thinks his previous forecast of 2.65 per cent may be conservative.

However, comments last week from MPC member Andrew Sentance suggested there are concerns on the committee about inflation pressures.

The retail prices index, on which many wage settlements are based is forecast to rise even more sharply than CPI.