Inflation at 2.5% after biggest rise for two years: Underlying figure stays below the Bank of England forecast

INFLATION leapt to a 13-month high of 2.5 per cent in January, while a rise in earnings growth for service sector workers suggested that inflationary pressure may be stirring in the labour market.

The rise in inflation from 1.9 per cent in December was the biggest in more than two years, but at the low end of City forecasts. Mortgage rate cuts in January were a third of last year's, while higher motoring and tobacco costs also pushed up the rate of price increases.

The Government's target measure of underlying inflation, which excludes mortgage interest payments, edged up from 2.7 to 2.8 per cent. This was below the Bank of England's forecast of 3 per cent.

The Government is committed to a target of 1 per cent to 2.5 per cent for underlying inflation by the end of Parliament in 1996 or 1997.

Simon Briscoe, of Warburg Securities, said underlying inflation was on course to fall to 2 to 2.25 per cent in the middle of the year.

The retail price index - the price of the basket of goods consumed by the average family - fell by 0.4 per cent in January, less than half the fall for the same period last year. This drop was more than accounted for by lower prices for household goods, clothing and footwear in the January sales.

The 5.1 per cent fall in clothing prices in January has not been exceeded in any month since 1921, while household goods prices are rising more slowly than at any time since records began in 1956.

Inflation in services fell sharply. The household services inflation rate dropped from 3.5 per cent in December to 1.9 per cent in January, the lowest since 1977. Motor insurance and telephone charges have also fallen. However, inflation still remains about twice as high for services as for tangible goods. The Bank of England has warned that if non-inflationary growth is to be maintained, short-term increases in inflation must not be reflected in pay increases. But Department of Employment figures suggest earnings growth may be accelerating.

The underlying growth rate of average earnings in service industries was 2.5 per cent in November and December, up one quarter point from the preceding two months. This was the first rise in nearly two years and reflected higher bonuses.

Earnings growth was unchanged at 4.25 per cent in manufacturing in the year to December, with November's figure revised up from 4 per cent because of bonus payments. Across the whole economy earnings growth was static at 3 per cent for the fourth successive month.

The Employment Department said the earnings figures had only been boosted by bonus payments and that it had no evidence yet of a rise in pay settlements. But the Confederation of British Industry has reported a pick-up in manufacturing settlements while Incomes Data Services has noted rises in settlements in manufacturing and services.

The combination of static earnings growth in manufacturing and falls in factory output and employment saw unit labour costs - a key measure of international competitiveness - rise at their fastest rate since the middle of 1992. The amount spent on wages and salaries to produce each unit of factory output was 1.2 per cent higher in December than a year earlier.

Separate figures from the Treasury and the Central Statistical Office showed that the Government raised pounds 1.6bn more in tax revenue than it spent last month, enabling it to cut its borrowing so far this financial year to pounds 30.2bn.

The public finances are normally in good shape in January because of a big inflow of corporation tax receipts, but the debt repayment last month was slightly smaller than City forecasts.

The public sector borrowing requirement for the first 10 months of the financial year rose more than one third over the same period last year. Excluding privatisation proceeds, the cumulative PSBR was pounds 5.8bn higher at pounds 33.6bn.

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