News that the underlying inflation rate hit 2.6 per cent in December, combined with evidence of returning consumer confidence, was poorly received in the City. Sterling rose to its highest level yet against the euro during afternoon trade amid fears that the Bank of England would hold fire on interest rates next month.
The Office for National Statistics said the rise in the underlying inflation rate was largely attributable to the increases in prices of seasonal food - such as potatoes - and household goods.
Analysts said the marked rise in prices of household goods was largely due to the "pre-January sales" effect. High-street retailers often raise prices before Christmas as this allows them to advertise sharp reductions at the start of the January sales.
The rise in prices of seasonal foods - which increased by 6.1 per cent in the month - was primarily caused by the poor weather, says the ONS. In the same period in 1997, seasonal food prices rose just 2 per cent.
City economists said the inflation figures - which also revealed that the headline rate sank to a seven-month low of 2.8 per cent - could provide the Bank with an excuse to leave rates unchanged next month.
However, several analysts emphasised that the overall trend in UK inflation was still downwards. Most expect the underlying rate to fall below target later this year.
Jonathan Loynes at HSBC Securities said: "We still expect RPIX [the underlying inflation rate] to drop below target as weaker costs push goods inflation into negative territory and slowing activity eases price pressures in services."
Fresh evidence of reviving consumer confidence also dented rate-cut hopes. GfK, the market research company, said confidence rallied in January following a string of interest-rate cuts by the Bank.
The GfK confidence barometer was minus 3 in January, up from minus 8 in December. Like other market researchers, GfK said that although consumers were gloomy about the general state of the economy, they were reasonably upbeat on the outlook for their personal finances.
GfK, which carried out its research on behalf of the European Commission, said there had been a sharp rise in employment intentions in businesses in the service sector.
There was fresh pressure on the Government yesterday to switch to an inflation target based on the harmonised European price index. It will be publishing this inflation measure alongside retail prices from next month.
Malcolm Bruce, the Liberal Democrat Treasury Spokesman, said the Chancellor should consider announcing the switch in his March Budget. The British Chambers of Commerce will also urge this move in its Budget submission.
Separate figures yesterday showed that the Government borrowed more than the City had expected last month. The Public Sector Net Cash Requirement (equivalent to the old Public Sector Borrowing Requirement) was pounds 3.2bn. But City experts still believe that the Government will easily meet this year's borrowing target of pounds 2.8bn.
Brazil raises interest rates
WORLD STOCK markets were shaken yesterday by the surprise increase in Brazilian interest rates on Monday night.
The central bank's decision to raise the prime lending rate from 29 to 41 per cent and the benchmark TBAN lending rate from 36 to 41 per cent achieved its aim of helping to stabilise the Brazilian currency. However, analysts warned of longer-term damage to economic growth.
Share prices fell in London and New York, where investors were worried by reports that seven Brazilian states were threatening to default on federal debts.
Brazilian share prices were trading modestly higher in relief that the central bank had stemmed the real's slide.