Going Green for Life

Surge in inflation set to trouble Bank of England

Inflation is now at a nine-month high and has moved substantially above the Bank of England's target level of 2%

Inflation surged in December. Photo: David Sillitoe

The rate of inflation jumped by a record amount in December, approaching the level at which Bank of England governor Mervyn King would have to write his sixth letter to chancellor Alistair Darling, explaining why inflation has crashed through the 3% threshold.

Official figures today showed the annual rate of consumer prices inflation (CPI) jumped to 2.9% in December, up from 1.9% the month before in the biggest rise since records began in 1997. Analysts had forecast an increase to 2.6%.

The Office for National Statistics said the increase was mainly due to the effects of last year's sharp falls in oil prices dropping out of the figures and VAT rising back to 17.5%, from 15%.

Describing the figure as "a very nasty shock", Howard Archer, chief UK economist at research group IHS Global Insight said even allowing for the unfavourable statistical distortions coming from sharply falling oil prices a year ago and the December 2008 VAT cut, the data "will not go down at all well at the Bank of England".

Inflation is now at a nine-month high and has moved substantially above the Bank of England's target level of 2%.

If CPI rises above 3%, King will have to write a letter to the chancellor explaining why. "Indeed, it now seems a stone dead certainty that Bank of England governor Mervyn King will be writing a 'Dear Chancellor' letter next month to explain why consumer price inflation in January rose more than one percentage point above its target level and what the Bank of England is doing about it," Archer said.

Vince Cable, the Liberal Democrat Treasury spokesman, said the figures were almost certainly a "temporary spike". "With inflation expected to fall quickly, it seems unlikely that the Bank of England would want to raise interest rates in the near future. Any recovery in the economy is still very fragile, it would be all too easy to destroy it by putting the brakes on too soon."

But he cautioned that the Bank still needed to be "acutely aware" of the longer term inflationary dangers.

"With the world economy improving at a much quicker rate than the UK, there is a danger that high food and energy prices could hit our economy before it has had a chance to recover," he said.

Inflation measured by the retail prices index, which includes housing costs and is used as the basis for many pay deals, jumped to an annual rate of 2.4%, from 0.3% the previous month. It was the highest rate since November 2008.

Sterling hit a four-month high against the euro, with the pound at €1.14½.

Mark O'Sullivan, director of dealing at foreign exchange firm Currencies Direct, said: "The current sterling rally looks like it may have the potential to move higher over the coming weeks.

"Although there are still considerable worries concerning the UK, both in its fiscal position and potential change of government, there is no doubt that January has proved the month to be long on sterling."