Rocketing food costs push inflation to 3.8%
Escalating food prices have pushed inflation up to an alarming 3.8% in June, well above the government’s official 2% target.
The Consumer Price Index (CPI) – the official measure of inflation – hit 3.3% in May, prompting the Bank of England’s governor to write to the chancellor Alistair Darling with an explanation. In his letter, governor Mervyn King warned inflation could reach 4% by the end of the year.
His stark forecast appears to be coming true, with the Office for National Statistics today announcing CPI was at 3.8% in June. The news has raised fears that interest rate cuts are out of the window, while interest rate rises could be on the cards.
The main reason for inflation moving so far above target is rocketing food prices. Food inflation alone hit 10.6% last month, with the cost of meat - particularly beef - now rising at a rate of 11.2%.
Meanwhile, elsewhere in the supermarket, fruit inflation hit 8.2% in June, from 2.4% the previous month, while breads and cereals saw an increase of 11.9%. Oil and butter prices were also considerably higher in June, reaching 28.2%.
But it’s not just food prices causing inflation to reach such dizzy heights. The rising cost of crude oil has pushed up petrol prices as well as utility bills, while digital cameras, DVDs and package holidays have also increased significantly.
Retail Price Inflation (RPI) - which includes mortgage payments - was also increased in June, from 4.3% the previous month to 4.6%. The Office For National Statistics says falling house prices and fewer mortgage payments prevented RPI from rising even higher.
Impact on interest rates
Peter Newland, an economist at Lehman Brothers, believes that members of the Bank of England's Monetary Policy Committee (MPC) - which sets interest rates - remain concerned about the risk of inflation passing into wages. If this happens, then high inflation can easily become entrenched in the economy.
However, Newland says that the economic slowdown should restrain inflation: "We continue to judge that the sharp slowdown in activity, that now appears to be happening, will restrain core inflation and wages and that, once the near-term spike in inflation passes, the next move in interest rates will be down."
Members of the MPC have also hinted that interest rate rises might not be their immediate reaction to rising inflation, and that cuts still lie ahead.
In a speech about inflation, MPC member Andrew Sentance said battling inflation was complicated, not least because of the impact of the credit crunch.
He said: "Our judgements on monetary policy clearly needs to take into account how much of a slowdown is in the pipeline already from these financial market and banking developments."
If this slowdown is influential enough on inflation, then rate rises might not need to happen in the short-term.
Kate Barker, also a member of the MPC, has hinted that rises are not at the top of the committee's to-do list. She warned against leaving interest rates at their current level for too long because of the danger it posed to the economy.
Barker told The Times: "The mistake we could make, and we are all worried about this, is of holding policy too tight, and the economy weakening more than is necessary to get inflation back on target."
Replaced as the official measure of inflation by the consumer prices index (CPI) in December 2003. Both the Retail Price Index and CPI are attempts to estimate inflation in the UK, but they come up with different values because there are slight differences in what goods and services they cover, and how they are calculated. Unlike the CPI, the RPI includes a measure of housing costs, such as mortgage interest payments, council tax, house depreciation and buildings insurance, so changes in the interest rates affect the RPI. If interest rates are cut, it will reduce mortgage interest payments, so the RPI will fall but not the CPI. The RPI is sometimes referred to as the “headline” rate of inflation and the CPI as the “underlying” rate.
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).