Inflation could hit 4% this year
The cost of living is increasing at a rate of 3.3% with inflation spiralling well beyond official targets, new figures reveal.
The Consumer Price Index (CPI) – the chosen measure of inflation in the UK – was 3% in April, but the rising cost of food such as meat and fresh vegetables pushed it up to 3.3% last month.
The Bank of England's governor, Mervyn King, has also warned that inflation could exceed 4% before the end of 2008.
The Bank of England’s remit is to keep inflation within 100 basis points of a 2% target. If inflation moves more than 1% above or below this target, then King is obliged to write to chancellor Alistair Darling to explain what actions he intends to take to counter rising prices.
The Bank of England was granted independence to control monetary policy, including setting interest rates, 11 years ago when Labour came to power in 1997. This is the second time King has had to put pen to paper, the first time being last April when inflation rose to 3.1%.
Rising food prices, as well as the increasing cost of gas and electricity, books and newspapers, are responsible to pushing inflation to its current rate. Higher price tags on alcohol and tobacco products, furniture and cleaning products are also to blame.
The Office of National Statistics, which publishes the CPI, says that during May prices of all consumer goods increased, meaning there was no downward pressure on inflation.
The Retail Price Index - which includes mortgages - also increased in May to 4.4% from 4% in April. Without falling house prices, this figure would have been even higher.
Pen to paper
In his letter to Darling, King says that current above-target inflation is probably "temporary". However, he predicts that he will have to put pen to paper more than once over the next year as inflation is likely to remain above the 2% mark until "well into 2009".
He added "As things stand, inflation is likely to rise sharply in the second half of the year, to above 4%."
Whether this means interest rate increases or not remains to be seen. King writes that the Monetary Policy Committee (MPC) - which sets rates - believes higher interest rates would result in "unnecessary volatility in output and employment".
But he adds: "To return inflation to the target, it will be necessary for economic growth to slow this year."
Such a sentiment appears to rule out any base rate cuts for now.
Lavinia Santovetti, an economist with investment bank Lehman Brothers, says CPI was higher than expected.
"We now expect the MPC to remain on hold until November, pushing back the rate cut from August to November. We think that by November, the growth outlook should have weakened enough to offset the upside risks to inflation, thus triggering a rate cut," Santovetti adds.
Higher food prices are largely to blame for May’s increase in inflation. The Office of National Statistics points to fresh vegetables as the food group experiencing the biggest increase in cost, especially lettuces.
Elsewhere, meat - such as bacon, poultry and sausages - has experienced a big increase in cost over the past year.
According to mysupermarket.co.uk, the price of a basket of staple foods has increased by 21% in the past 12 months. Dairy and wheat-based products have gone up the most, with fruit and vegetables catching up fast.
ASDA shoppers are feeling the pain of rising prices the most, according to the comparison website, with a shopping basket of food up 26% since last year. In comparison, Tesco shoppers are having to fork out 16% more while Sainsbury’s shopper are spending 21% more.
Johnny Stern, director of mySupermarket.co.uk, says: “Once again, we’re seeing a significant price increase in staple items. Unfortunately, prices of staples overall are going up, although elsewhere in the supermarket there are some product prices which have been cut.”
Stern recommends shoppers stick to a tight budget when doing a supermarket shop, and look out for better priced like-for-like items and special offers.”There are significant and regular savings to be had to combat the crunch,” he adds.
Monetary Policy Committee
A committee designated by the Bank of England to regulate interest rates for the UK. The MPC attempts to keep the economy stable, and maintain the inflation target set by the government and aims to set rates with a view to keeping inflation at a certain level, and avoiding deflation. The MPC meets on the first Thursday of each month and discusses a variety of economics issues and constitutes nine members: the governor, the two deputy governors, the Bank’s chief economist, the executive director for markets and four external members appointed directly by the Chancellor.
An increase in the general level of prices that persists over a period of time. The inflation rate is a measure of the average change over a period, usually 12 months. If inflation is up 4%, this means the price of products and services is 4% higher than a year earlier, requiring we spend and extra 4% to buy the same things we bought 12 months ago and that any savings and investments must generate 4% (after any taxes) to keep pace with inflation. Since 2003, the Bank of England has used the consumer prices index (CPI) as its official measure of inflation (see also retail prices index).
The Consumer Price Index is the official measure of inflation adopted by the government to set its target. When commentators refer to changes in inflation, they’re actually referring to the CPI. In the June 2010 Budget, Chancellor announced the government’s intention to also use the CPI for the price indexation of benefits, tax credits and public sector pensions from April 2011. (See also Retail Prices Index).
Also referred to as the bank rate or the minimum lending rate, the Bank of England base rate is the lowest rate the Bank uses to discount bills of exchange. This affects consumers as it is used by mainstream lenders and banks as the basis for calculating interest rates on mortgages, loans and savings.