Rising cost of food prompts interest rate fears

15 January 2008

The wholesale cost of food has increased by over 7% in the past yearsparking fears that inflation may prevent the Bank of England from cutting interest rates.

Figures from the Office of National Statistics show that over the past 12 months the cost of food products has risen 7.4%. This increase in food and non-alcoholic costs has put upward pressure on inflation, with the ONS noting that vegetables like cauliflowers, tomatoes and onions plus bread, sugar, and confectionery are some of the worst offenders.

Despite the rising cost of food, inflation remained stable at 2.1% in December.

The ONS says that increases in household services such as energy bills have been smaller than in previous years, which has helped keep inflation unchanged from November.

However, with npower already increasing the cost of it gas and electricity and other providers predicted to follow suit, fears are rising that this could push inflation further away from the Government's 2% inflation target.

And this may have a knock-on impact on interest rates. If inflation does rise because of food and energy costs then the Bank of England’s forecast interest rate cut in February could be less of a done deal.

But Ian Kernohan, economist at RLAM, says that a rate cut shouldn't be ruled out.

He adds: “Producer price inflation is very high, particularly in areas such as food, but there is no guarantee that retailers can pass these costs on to the consumer in the belt-tightening environment we have at present.”

And Simon Denham, managing director of Capital Spreads, has argued that higher interest rates do not necessarily fight inflation on essential spending such as on food.

Denham says: “Current inflationary pressure is being created by food, energy, transport, taxes and Government spending, none of which will be affected by what little old Britain decides to put its rates at.”

Rising inflation at a time when consumer spending and the housing market are slowing is a concern for economists.

Stephen Gifford, chief economist at Grant Thornton, says inflationary risks such as rising food costs mean the Bank of England will not be able to cut interest rates by as much or as quickly as it might otherwise like.

But he says: “We are still forecasting a 0.25% interest rate cut in February - another rate freeze will be hard for the market to take. However, there will be a longer gap between that cut and the next one."

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