Inflation boosts benefits but brings no joy to the City

A higher headline rate of inflation last month means the state pension for a couple will climb above pounds 100 a week for the first time next April. But Diane Coyle, Economics Editor, warns that this good news for pensioners is unlikely to please the Bank of England.

Retail price inflation climbed to 3.6 per cent in September, the month whose figure forms the basis for uprating a wide range of social security benefits from April. The figure, somewhat higher than the pundits expected, is good news for people receiving inflation-linked benefits like the state pension. Child benefit will also go up in line with prices.

The increase in headline inflation was due partly to higher mortgage payments. The underlying rate, which excludes these, declined to 2.7 per cent from 2.8 per cent in August and is likely to reach the Government's 2.5 per cent target before long.

Alistair Darling, Chief Secretary to the Treasury, said, ultra-cautiously, that the small fall in the target measure "provides further evidence that the economy is on course to get back on track".

However, economists in the City warned that the Bank of England's Monetary Policy Committee will still raise interest rates again. A few said they could even take action to slow the economy further after their meeting today and tomorrow.

"I'd put the probability of an increase this week as high as one in three," said David Walton of investment bank Goldman Sachs. He said rising headline inflation would have a knock-on effect to pay settlements at a time when earnings were already picking up.

Most experts reckon the Bank will hold off until November to get further evidence. But, even though the Confederation of British Industry said yesterday's inflation figures showed there was no need to increase the cost of borrowing again, the general reaction in the City was one of disappointment.

Although higher housing costs and food prices explained most of the rise in the headline rate, from 3.5 per cent the previous month, the strong pound should be helping reduce inflation faster. Economists said retailers were taking the opportunity to raise their margins in the face of strong consumer demand.

For example, the price of foreign holidays was 8 per cent higher than a year earlier, despite the drop in overseas costs in sterling terms. Even household goods inflation, at a low 0.9 per cent, has stayed flat for four months despite falling import prices.

David Bloom of James Capel said: "Goods prices should be falling more rapidly with the pound so strong, and services inflation has started to climb again."

Not all the analysts were so gloomy. Simon Briscoe at Nikko Europe said the figures fully justified a policy of "wait and see" on interest rates. But he, too, admitted that rising services prices were a worry.

Some services saw pronounced jumps last month. Estate agents pushed up their fees by 2 per cent, and other housing-related costs like conveyancing fees also rose.

Private school fees at the start of the autumn term also had a noticeable impact on inflation, although mainly because their weight in the Retail Price Index has doubled since last year. This reflects their increased share in expenditure by families.

What's more, the decline in the underlying rate of inflation was fully explained by the cut in VAT on domestic energy to 5 per cent announced in the Budget. Big increases in excise duties that come into force in December will tend to push the rate back up.

The silver lining, at least for some, was the impact higher headline inflation has on many social security benefits.

The state pension for a couple will climb from pounds 99.80 to pounds 103.40. Child benefit is also to increase in line with prices, by 40 pence a week to pounds 11.45 for the first child and by 30 pence a week to pounds 9.30 for subsequent children, the Department for Social Security said.

Some other benefits, including the disability living allowance, incapacity benefit, sickness benefit and the invalid care allowance will also increase by 3.6 per cent from April.

However, some benefits are linked to a figure for inflation excluding most housing costs. These - income support, the Jobseeker's Allowance, Family Credit, housing benefit, council tax benefit and the disability working allowance - will go up by only 2.4 per cent.

And the DSS confirmed that the Government is sticking to its heavily criticised decision to live with the reduction in one-parent benefit announced by the Conservatives.