Shock surge in inflation

19 January 2010

A surge in inflation in December makes it increasingly likely that the Bank of England will bring its quantitative easing programme to a close in February, economists said today.

The Consumer Prices Index (CPI) jumped from 1.9% in November to 2.9% in December to record its largest jump in the annual rate since records began in 1997 - and well above consensus estimates of 2.6%.

It now stands at a nine-month high, pushed up by the unfavourable base effects resulting from the temporary VAT rate of 15% and oil prices falling sharply in December 2008. Lower levels of discounting by retailers in December 2009 compared to a year ago also contributed to the rise.

Meanwhile, the Retail Price Index (RPI) - which includes housing costs - also climbed sharply, up from 2.1% in November to 2.4% in December 2009.

Economists say the latest inflation figure comes as “a very nasty shock”. Core inflation, which excludes volatile energy and food prices, increased to 2.8% over 2009 despite the UK experiencing the longest and deepest recession since the Second World War.

They expect that inflation will rise further – well above the Bank of Engand's November forecast of 3% - following the return of VAT to its 17.5% level in January.

Howard Archer, economist of IHS Global Insight, warns that inflation could now take longer to fall towards the central bank’s medium term 2% target.

He explains: “While the Bank of England has indicated that it will look through the near time spike up in inflation and will focus on price prospects over the longer-term, it must be worried by the nasty December data.

“Indeed, the December inflation data not only make it even more likely that the Bank of England will call a halt to its quantitative easing programme at its February meeting (particularly as the economy seemingly returned to growth in the fourth quarter of 2009), but also increase the risk that the central bank could start raising interest rates well before the end of 2010."

But Azad Zangana, European economist at Schroders, adds: “While the latest inflation estimates are a surprise, we do not expect the Bank of England to panic and raise interest rates. This should spell the end of quantitative easing in February, but worries over growth and rising unemployment will keep the monetary policy committee in ‘wait and see’ mode for some time.”

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