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Bank hedges bets on inflation

The Bank of England will say in its Inflation Report today that the Government remains more likely than not to hit its 2.5 per cent inflation target. But it will also emphasise early warning signals such as higher costs, stronger consumer spending and rapid monetary growth.

The report follows official figures yesterday showing that inflation at the factory gate fell last month to its lowest since December 1994.

However, higher oil and food costs meant the price of some materials bought by manufacturers picked up sharply.

There was also new evidence confirming the stronger trend in retail sales, especially for housing-related items such as furniture and carpets.

April's figures were hit by the early Easter, according to the British Retail Consortium, but annual growth in the volume of retail sales taking March and April together was 4.4 per cent against an average of 4 per cent during the winter months.

Eddie George, Governor of the Bank of England, said yesterday that inflationary pressures remained subdued.

Most City of London analysts agreed. Simon Briscoe, an economist at Nikko Securities, said: "The downward trend in output prices is very encouraging for retail price inflation over the next year or so."

Evidence on the strength of the economy since the Bank's February Inflation Report has been mixed. Ahead of retail prices for April due later this week, the Bank is expected to forecast that the target measure of inflation will fall further in the short run but that the risks of higher inflation in the medium term have increased.

Yesterday's producer price figures confirmed that manufacturers have been unable to pass on cost increases. Their output prices rose 0.3 per cent in April, reducing their year-on-year increase to 3.2 per cent from 3.5 per cent. "Core" prices, excluding food, drink and tobacco and petroleum, rose 0.1 per cent, taking their annual inflation rate down to 2.8 per cent.

The monthly increase in input costs was disappointingly high at 0.8 per cent, mainly because of higher prices for crude oil, grains and cocoa.

The 12-month rate of growth increased from 2.8 per cent to 3.1 per cent.

Core input prices rose 0.3 per cent in April but fell 0.3 per cent in year-on-year terms, leading some economists to argue that there were no worrying inflationary implications. They see dearer oil and food, which make up nearly a third of the index of manufacturers' input prices, as temporary.

However, others were more concerned about the potential impact on inflation further down the pipeline. Michael Dicks at investment bank Lehman Brothers said: "There are latent cost pressures. If demand strengthens we will see firms passing them on."

The financial markets reckon there is no scope for another reduction in base rates from the current level of 6 per cent.

Mr George said long-term interest rates in the UK would fall if the Bank of England had explicit responsibility for keeping prices stable. That was more important than independence, he argued.

In an interview with French financial daily La Tribune yesterday he said: "That would improve the credibility of monetary policy, which would have an impact on long-term yields, because we would not take any risks."